Which of the following statements is CORRECT? A. Since depreciation is a cash ex

Question

Which of the following statements is CORRECT?

A. Since depreciation is a cash expense, the faster an asset is depreciated, the lower the projected NPV from investing in the asset.

B. Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer.

C. Corporations must use the same depreciation method for both stockholder reporting and tax purposes.

D. Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project’s forecasted NPV.

Explanation / Answer

Correct Statement is D- Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project’s forecasted NPV.

Accelerated depreciation allows companies to write off their assets faster in earlier years than the straight-line depreciation method and to write off a smaller amount in the later years. The major benefit of using this method is the tax shield it provides. Companies with a large tax burden might like to use the accelerated-depreciation method, even if it reduces the income shown on the financial statement as the actual cash flow would be higher due to lower income tax outflow.

Depreciation is a non cash expense. Further US GAAP does not prescribe any particular method for calculation of depreciation instead it suggests that method that is appropriate in the context of the asset to be used. Also calculation of depreciation for income tax purpose and financial reporting purpose are different as IT department has its own set of rules for the calculation.

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