Question

Discuss a business example that shows how depreciation and

accelerated depreciation can affect project cash flows.
What would your process be to ensure that all related financial
details are allocated

Answer 1

Depreciation and accelerated depreciation can have an impact on project cash flows in a business. One example is a construction company that purchases heavy machinery and uses either straight-line depreciation or accelerated depreciation methods. This affects project cash flows through changes in taxable income and tax deductions.

Step-by-step explanation:

Depreciation is the gradual loss of value of an asset over time, and it can impact project cash flows as it is considered an expense. Accelerated depreciation, on the other hand, allows for a faster depreciation of the asset, resulting in larger tax deductions and potentially improving project cash flows in the short term.

For example, let's consider a construction company that purchases heavy machinery. The company estimates that the machinery will have a useful life of 5 years and has a total cost of $500,000. If the company uses straight-line depreciation, the depreciation expense would be $100,000 per year ($500,000/5 years). This depreciation expense will reduce the taxable income, which in turn lowers the amount of taxes the company has to pay, thus affecting project cash flows.

Now, let's say the company decides to use accelerated depreciation. It could use the double-declining-balance method, which results in a larger depreciation expense during the earlier years of the asset's life. This means that the tax deductions will be higher in the early years, providing immediate tax benefits and potentially improving project cash flows even further.

Answer 2

Depreciation is an accounting method of spreading the cost of a tangible asset over its useful life. An example can be a company purchasing equipment and using either straight-line or accelerated depreciation to affect project cash flows by reducing tax liabilities. Proper allocation involves maintaining records, picking the correct depreciation method, reviewing schedules, and understanding tax impacts.

Step-by-step explanation:

Depreciation is the accounting process of allocating the cost of tangible assets over their useful lives. It allows businesses to generate revenue from an asset while expensing a part of its cost each year the asset is in use. In terms of project cash flows, depreciation does not directly affect cash flow since it's a non-cash expense. However, it can indirectly affect cash flows through its impact on taxes.

Business Example

Consider a company that purchases a piece of equipment for $100,000 with a useful life of 10 years. Under straight-line depreciation, the company would deduct $10,000 from its revenue each year as a depreciation expense. With a tax rate of 30%, this depreciation deduction would save the company $3,000 in taxes annually ($10,000 * 0.30), effectively improving its cash flow by that amount.

In the case of accelerated depreciation, such as double-declining balance, more of the asset's cost is depreciated in the early years. If the company uses accelerated depreciation and deducts $20,000 in the first year, the tax savings would be $6,000 in that year ($20,000 * 0.30), thereby increasing the project's cash flow more in the early stages but less in the later years when the depreciation expenses are lower.

To ensure all related financial details are allocated, it's crucial to:

1. Maintain accurate financial records for all assets.
2. Choose an appropriate depreciation method that matches the asset usage pattern.
3. Regularly review and update the depreciation schedules to reflect any changes in asset life or salvage value.
4. Consult tax laws to understand how depreciation methods affect tax liabilities and cash flows.