The CFA text says that an impairment loss will not affect cash flows. I do not see it explain this point further. Earnings are reduced, so why are taxes not reduced and therefore operating cash flow increased?
When looking at accelerated depreciation vs. straight line, I believe CFO would be increased if switching to accelerated so I am just not understanding why an impairment loss would not also increase CFO.
as i remember, change dep method also not affect CFO
Depreciation does not affect CFO; to remember , look at FCF formulas.
An impairment loss is a non-cash event (like depreciation or a gain on the sale of an asset). Yes, it’s reported in earnings, but each of the those situations are then added/subtracted from Net Income on the Statement of Cash Flows to get to CFO. CFO is ACTUAL CASH, net income is just an accounting measure and isn’t indicative of your cash earnings.
Of this I’m a little less certain - but accelerated and SL depreciation result in the same CFO because cash tax savings are based on the tax depreciation method (which is MACRS for many US firms).
Eveyone seems to be of the same opinion that depreciation doesn’t affect cash flows. If it does not, why do companies use accelerated depreciation for tax purposes? I understand that depreciation itself is a non-cash charge, but higher depreciation leads to lower EBT, which leads to lower taxes. As the company is paying lower taxes, CFO is higher.
Take a look at the answer in the CFA EOC for #2 (P.101). “Switcing to an accelerated depreciation method would increase depreciation expense and decrease income before taxes, taxes payable and net income. Cash flow from operating activities would increase because of the resulting tax savings”.
So I am wondering why impairment loss would not have a similar effect as depreciation (if you agree with me on depreciation).
Ahhh, the problem states that depreciation method is changed for both financial and tax reporting purposes. I originally assumed it just changed from one to the other for financial reporting. In that case, you’re correct regarding your conclusion about the effect on taxes.
Impairments do not reduce taxable income (tax reporting). Thus, cash taxes paid will not be less than if the company had not recorded an impairment loss in the financial statements. Just remember that there will be a disparity between income for tax reporting and financial reporting, all else equal, if there is an impairment.
That second paragraph probably could have been written better - holla if you need help translating.
Probably the same concept applies here, in corporate finance and in LIFO invenotry system. Accelerated dep increases cash flows because of tax savings in all cases.
Thanks. Where would it show up in the income statement? Would it be below the line so just subtracted from net income.
Impairments appear in P&L as part of operating expenses - wouldn’t be an extraordinary item that would appear below the line.
There is no effect below the line. Taxes simply go down by (amount of additional dep x TR). But when you add NCC to free cash flows or CFA you add the entire amount (without taxes).
I mean in terms of depreciation.
IMO impariments appear in operating expenses.
Ok, so I guess the key (as you say above) is that EBT will be higher for tax reporting purposes, as the impairment charge is included in the financial reporting statements but excluded for tax reporting purposes. Thanks all for the help.