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    Discuss The Impact of Depreciation Expense Unit2

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    Djahan Rana
    Depreciation expense reduces reported net income on a company's income statement but does not impact cash flow, except for the full amount in the year an asset is purchased. There are two main types of leasing arrangements - operating leases, where the lessor records depreciation and the lessee records lease expenses, and capital leases, where the lessee records depreciation and splits lease payments into interest and principal components. Both leasing types have pros and cons regarding financial reporting and tax implications for the lessee and lessor.

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    Discuss The Impact of Depreciation Expense Unit2

    Uploaded by

    Djahan Rana
    247 views2 pages
    Depreciation expense reduces reported net income on a company's income statement but does not impact cash flow, except for the full amount in the year an asset is purchased. There are two main types of leasing arrangements - operating leases, where the lessor records depreciation and the lessee records lease expenses, and capital leases, where the lessee records depreciation and splits lease payments into interest and principal components. Both leasing types have pros and cons regarding financial reporting and tax implications for the lessee and lessor.

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    FIN MGT 5111

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    Discuss the impact of depreciation expense unit2

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    Depreciation expense reduces reported net income on a company's income statement but does not impact cash flow, except for the full amount in the year an asset is purchased. There are two main types of leasing arrangements - operating leases, where the lessor records depreciation and the lessee records lease expenses, and capital leases, where the lessee records depreciation and splits lease payments into interest and principal components. Both leasing types have pros and cons regarding financial reporting and tax implications for the lessee and lessor.

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    247 views2 pages

    Discuss The Impact of Depreciation Expense Unit2

    Uploaded by

    Djahan Rana
    Depreciation expense reduces reported net income on a company's income statement but does not impact cash flow, except for the full amount in the year an asset is purchased. There are two main types of leasing arrangements - operating leases, where the lessor records depreciation and the lessee records lease expenses, and capital leases, where the lessee records depreciation and splits lease payments into interest and principal components. Both leasing types have pros and cons regarding financial reporting and tax implications for the lessee and lessor.

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    of 2

    • Discuss the impact of depreciation expense on the cash flow analysis of a capital project.

    To begin, let me first say that depreciation has a direct impact on profit that appears on a company’s
    income statement. So basically if the depreciation expense for the year high it reduces the company
    net income for that particular year. However, because depreciation is a non-cash expense it does
    not have any impact on the company cash flow.
    However there is a full or a significant impact on the first year of the project or the year of purchase
    of the asset since the full amount will be remove or less from the cash flow. For example if Company
    X purchases a car for 20,000 it will be less from the cash flow for the year of purchases. If the asset
    has a useful life of 5 years, using straight-line method it will depreciate 4,000 ever year on the
    income statement however this will have no impact on the cash flow. Merritt, C. (2019, January 11).
    Discuss the types of leasing arrangements and their pros and cons relating to depreciation
    expense. 

    There are two general types of lease, which are:


    Operating lease- An operating lease is a financing arrangement under which the lessor officially
    owns the leased asset and records the asset in its financial records. The lessor therefore records the
    depreciation expense associated with the asset. The lessee only records a lease expense in each
    period, in the amount of the payment made to the lessor. (Bragg, S. 2018, September 15).

    Advantages of an Operating Lease


     Operating leases provide greater flexibility to companies as they can replace/update their
    equipment more often
     No risk of obsolescence, as there is no transfer of ownership
     Accounting for an operating lease is simpler
     Lease payments are tax-deductible
    (Capital Lease vs Operating Lease - What You Need to Know. n.d.).

    Disadvantages of an Operating Lease


     higher level of expenses reported
     The leased asset appears nowhere as an asset on the company’s accounting records
    (McIntosh, K. A. 2019, February 11).

    Capital lease- The roles of the two parties are reversed under a capital lease. Under this
    arrangement, the lessee records the asset in its records, and recognizes depreciation expense. The
    lessee splits apart all payments made into their interest and principal components, and records each
    element separately. In essence, the arrangement is treated as a loan that is used by the lessee to
    buy the asset. (Bragg, S. 2018, September 15). 

    Advantages of a Capital Lease


     Lessee is allowed to claim depreciation on the asset, which reduces taxable income
     Interest expense also reduces taxable income
    (Capital Lease vs Operating Lease - What You Need to Know. n.d.).

    Disadvantage of a Capital Lease


     Negative debt-to-equity ratio
     The possibility of being obsolete
     Maintenance responsibilities
    (Borad, S. B. B. S., & Borad, S. B. 2019, February 25).

    Reference
    Merritt, C. (2019, January 11). What Is the Impact of Depreciation Expense on Profitability?
    Retrieved from https://smallbusiness.chron.com/impact-depreciation-expense-profitability-
    55349.html

    Bragg, S. (2018, September 15). Leasing. Retrieved from


    https://www.accountingtools.com/articles/2017/5/12/leasing
    Capital Lease vs Operating Lease - What You Need to Know. (n.d.). Retrieved from
    https://corporatefinanceinstitute.com/resources/knowledge/accounting/capital-lease-vs-operating-
    lease/
     
    Borad, S. B. B. S., & Borad, S. B. (2019, February 25). Advantages and Disadvantages of Capital
    Lease: Lessee & Lessor Outlook. Retrieved from https://efinancemanagement.com/sources-of-
    finance/advantages-and-disadvantages-of-capital-lease

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