Simply said, a capital project is a lengthy, expensive expenditure (Barone, 2019).

A capital

project's cash flow analysis enables a closer examination of the project's cash inflows and

outflows (Project-Based Cash Flow Analysis Guide | Smartsheet, n.d.). Depreciation costs have

no discernible influence on a capital project's cash flow analysis. The real-world impact on cash

flow of depreciating an asset through depreciation expense is the same as that of cash

accounting, which records revenues when cash is received and expenses when cash is paid. Cash

accounting requires the full cost expended on an asset to be spread over the asset's useful life.

This real-world result is that there is only a cash outflow at the start of the capital project and

none at any point thereafter (Merritt, 2019). There can only be extra cash withdrawals for

maintenance and repairs after the first investment (Pinkasovitch, 2022).

Forms of lease agreements

There are essentially two different kinds of leasing agreements. They are the operating lease and

the capital lease.

A capital lease grants the lessee the ownership and use of an asset, and these leases are listed as

assets on the lessee's balance sheet. Here, depreciation expense enables the full lease cost to be

depreciated over time so that the lessee's financial statements comply with accrual accounting

rules, which in and of itself has many benefits. This is because the present value of all lease

payments is 90% or more of the original cost of an asset (Hays, 2021). Depreciation expense

enables its full lease cost to be amortized over time in order to comply with accrual accounting

standards, which has many benefits in and of itself. Additionally, depreciation expense does not

affect the company's (the lessee's) cash flow; rather, it enables it to monitor the asset's

depreciation and ensure that it is used to the fullest extent possible, resulting in a higher than
necessary or the required rate of return. The company's taxable income and tax obligation

increased as a result of the incurred depreciation charge. Another is the direct impact the cost has

on the company's earnings during each accounting year: as a result, the lower the company's

reported profit is in a given year, the higher the depreciation expense on a lease is in that year

(Merritt, 2019).

A lessee may only use an asset temporarily under an operating lease (right of use only). Here,

lease payments are seen as operating expenses, with the lessee's only obligation being

maintenance fees for the asset. Depreciation expenses are impliedly not incurred because

operating expenses are not subject to depreciation in the same way that assets are. Assets are still

expensed on the income statement, affecting operating and net income even though this lowers

the lessee's taxable income and tax liability (Tardi, 2021).

References:

Barone, A. (2019). Capital Projects: What You Need to Know. Investopedia.

https://www.investopedia.com/terms/c/capital-project.asp.

Hays, A. (2021, August 25). Capital lease. Investopedia. Retrieved from

https://www.investopedia.com/terms/c/capitallease.asp.
Merritt, C. (2019, January 11). What Is the impact of depreciation expense on profitability?

https://smallbusiness.chron.com/impact-depreciation-expense-profitability-55349.html.

Pinkasovitch, A. (2022, January 27). An Introduction to Capital Budgeting. Investopedia.

https://www.investopedia.com/articles/financial-theory/11/corporate-project-valuation-

methods.asp.

Project-Based Cash Flow Analysis Guide | Smartsheet. (n.d.). Www.smartsheet.com. Retrieved

September 12, 2022, from https://www.smartsheet.com/content/project-cash-flow?amp.

Tardi, C. (2021, September 5). Operating lease. Investopedia. Retrieved from

https://www.investopedia.com/terms/o/operatinglease.asp.