Exercise 9-18 Sarasota Corp. reported net income of $58,500. Depreciation expens
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Question
Exercise 9-18
Sarasota Corp. reported net income of $58,500. Depreciation expense for the year was $127,000. The company calculates depreciation expense using the straight-line method, with a useful life of 10 years. Top management would like to switch to a 15-year useful life because depreciation expense would be reduced to $82,000. The CEO says, “Increasing the useful life would increase net income and net cash provided by operating activities.”
Provide a comparative analysis showing net income and net cash provided by operating activities (ignoring other accrual adjustments) using a 10-year and a 15-year useful life. (Ignore income taxes.)
Explanation / Answer
Particulars 10 year life 15 year life
Net Income 58500 103500
Net cash provided by Operating 185,500 185,500
Working Notes:
1. Income considering 10-year useful life os asset is $58,500. The moment, useful life is increased, depreciation per year will become small as compared to earlier which in turn will incrase the income. Impact on depreciation would be $127,000- $82,000= $45,000 which will take net income to $58,500+$45,000= $103,500
2. Let's assume that depreciaion is the only non-cash expense. Cash flow from Operating activitry will be comptuing by adding back the non-cash expense. But in both the cases, Net cash will remain same since it is just elimination of non-cash expenses.
In case if Income tax is applicable, CEO statement will hold true. Company will claim more depreciation in case of 10 year life which will reduce the tax burden on comapny. If tax burden is reduced, it will automatically increase the net cash. In case we ignore income tax, change in years of life of asset wouldn't impact the net cash provided by Operating activities.
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