Lucy\'s Music Emporium opened its doors on January 1, 2012, and it was granted p
ID: 2778313 • Letter: L
Question
Lucy's Music Emporium opened its doors on January 1, 2012, and it was granted permission to use the same depreciation calculations for shareholder reporting and income tax purposes. The company planned to depreciate its fixed assets over 20 years, but in December 2012 management realized that the assets would last for only 15 years. The firm's accountants plan to report the 2012 financial statements based on this new information. How would the new depreciation assumption affect the company's financial statements? The firm’s reported net fixed assets would increase.
a.The firm’s EBIT would increase.
b. The firm's reported 2012 earnings per share would increase.
c. The firm's cash position in 2012 and 2013 would increase.
d. The firm’s net liabilities would increase.
Explanation / Answer
As per the assumption “that the assets would last for only 15 years instead of 20 years” lead to higher Depreciation amount.
a) EBIT is calculated = EBITDA – Depreciation
If depreciation amount increased then EBIT will decrease if other things remaining constant.
b) If EBIT decreased then Profit after Tax will decrease as well
Earnings per share = Profit after tax / number of shares
As Profit after tax decreased then Earnings per share will also decrease
c) When Cash position is calculated = Net profit + Depreciation
As depreciation increased then cash position will also increased
d) Net liability will not be affected.
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