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- Title
DEPRECIATION'S EFFECT ON CAPITAL BUDGETING METRICS NEEDS MORE EDUCATOR FOCUS.
- Authors
Allen, Darryl E.; Idlebird, Jo Lacy
- Abstract
Numerous studies have examined the perceived weakness of newly hired accountants' analytical skills related to capital budgeting activities. This study extends that research by focusing on identifying the cash tax benefits of noncash expense allocations such as depreciation, depletion and amortization, often referred to as "capital recovery" or "tax shield". These benefits significantly affect the NPVs and IRRs of long-lived assets, especially when government tax incentives are provided to spur investment. In this paper, we examine 315 MSA students' understanding of how depreciation expense reflected on the financial statements provides a capital recovery/tax shield. Students received a balance sheet, income statement and a statement of cash flows to review, in addition to case specifics regarding the construction of an apartment building. The two versions of our statements reflected direct and indirect formats of the statement of cash flows. We asked the students whether, in the end, the building was a good investment. We find that very few MSA students (6%) correctly calculated the capital recovery/tax shield provided by the investment. Further, we found that the format of the statement of cash flows did not affect students' accuracy, but did significantly change the incorrect answer given. This is an important finding, since students trained in accounting should not be influenced by the method of reporting for the statement of cash flows. Our finding indicates that in addition to being ill-prepared to address the effects of non-cash items, they are significantly influenced by the reporting method used for the statement of cash flows. Additional research should be conducted on the influence presentation method has on the accounting students' use of the statement of cash flows for budgeting decisions. Limitations include our use of financial statements to determine students' ability to identify the capital recovery/tax shield from a capital project. Usually these projects are evaluated using net incomes and adjustments for capital recovery/tax shields to develop cash flows for NPV, IRR or other metrics. In addition, the calculation of capital recovery/tax shields is only part of the capital budgeting activities of a firm.
- Subjects
MARGINAL efficiency of investment; CAPITAL budget; NET present value; INTERNAL rate of return; CAPITAL investments; INFRASTRUCTURE (Economics); MANAGEMENT
- Publication
American Journal of Business Research, 2014, Vol 7, Issue 1, p45
- ISSN
1934-6484
- Publication type
Article