The impact of depreciation expense on the cash flow analysis of a capital project

The depreciation is a non-cash expenses and directly do not have any effect on cash flows, but it

is an important to capital projects. On that reason, it is added to the cash flow back during

calculations, because of the organization or business never spent the physical cash. However, it

can appear like depreciation has no effect on cash flow. First, depreciation amount is subtracted

while calculating the net income when making the income statement. In addition to this,

depreciation affects cash flows in an indirect way. (Hill, 2008)

The depreciation is a non-cash expense and it is tax deductible. So, this means, depreciation

amount a business pays, has effects on the taxes payable. When depreciation expense subtracted

from the tax and the business or company get the profit after tax figures. (Hill, 2008)

However, the higher the depreciation, the lower the taxable profit will be and as a result the

lower the tax amount payable will be. Depreciation indirectly affects the cash flow by reducing

the amount of taxes paid and a high depreciation may have a positive impact on the cash flows.

Accelerated depreciation methods will provide a higher tax shield upfront as compared to

straight line methods. When discounting these tax shields, the concept of time value of money

applies. For this reason, that accelerated method of depreciation is preferred to straight line

methods. (Hoyle J.B & Heisinger K., 2012)

The types of leasing arrangements and their pros and cons relating to depreciation expense

Leasing can be defined as an agreement between two parties where in one part transfer the right

to use an asset for an agreed period of time to another part for a lease payment. (Hill, 2008)

There are two types of leases.

An operating lease is treated like renting. The lease payment is considered as operating expenses.

Assets being leased are not recorded on the company’s balance sheet. They are expense on the

income statement which affects both operating and net income. (Hoyle J.B & Heisinger K.,

2012)

The cons of depreciation expense on this type of lease are that, the risk of ownership does not

transfer to lessor the lessor himself shows in his books of accounts the depreciation. Capital lease

is like a long-term loan or ownership. The asset is treated as being owned by the lessee and is

recorded on the balance sheet. Capital lease are considered as debt, depreciate overtime and incur

interest expense. (Hill, 2008)

The cons of depreciation expense on this type of lease are that the risk of ownership is

transferred to lessee and the lessee himself shows in his books of accounts the depreciation

expenses. So, Accrual accounting allows the inclusion of capital lease as an economic event that

requires a company to calculate the present value of an obligation on its finance statements.

(Hoyle J.B & Heisinger K., 2012)

Works Cited
Hill, R. A. (2008). strategic financial management . bookboon.com.

Hoyle J.B & Heisinger K. (2012). Accounting for Managers. Saylor Foundation .