Question
7. Which of the following statements is true? (i) Depreciation is a cash item, and it is important for calculating NPV (ii) Depreciation is an accounting adjustment,, and useful for accounting profit computations (iii) Depreciation is a relevant expense for short-term decision -making (iv) Depreciation is a cash item and appears in the cash budget.
Answer
4.4
(300 Votes)
Yancy
Master · Tutor for 5 years
Answer
(ii), (iii)
Explanation
Depreciation is a method of allocating the cost of a tangible or physical asset over its useful life or life expectancy. It represents how much of an asset's value has been used up. From the options given, let's evaluate each of them:(i) Depreciation is not a cash item, even though it's important for the calculation of Net Present Value (NPV). This is because while it does not represent an actual cash outflow, it impacts the tax trigger which subsequently alters the cash flow streams and hence, impacts NPV. So, first part of this statement is False but the second part is True.(ii) Depreciation also plays a role in determining a firm's tax liabilities. By depreciating an asset, a company can reduce its taxable income and thus, its tax liabilities as it implyes recognition of costs associated with asset use. Therefore, depreciation is crucial in accounting profit calculations. This statement is completely True.(iii) For short-term decision making, usually only relevant costs are considered. Depreciation, in most cases, i.e. for assets already into service, would have been treated as a sunk cost and thus would not be relevant for consideration in day to day operational decision making. Except for the decisions related to replacing the current asset with another one, whereon we need to calculate the salvage value alongwith depreciated value for the equipment for consideration. This statement seems to be True.(iv) Depreciation charges appear in the standard accounting profit and loss statement since they describe decrease in value of company assets. It is not a cash item and hence does not appears in cash budgets. Cash budgets only accommodates actual cash transactions. So, it's a False statement.Evaluating the basis of all these options, seems like only statements (ii) and (iii) appear to be completely true.