If a $100 asset write-down occurs with a 40% tax rate, what is the resulting effect on Shareholders' Equity?

If a $100 asset write-down occurs with a 40% tax rate, what is the resulting effect on Shareholders' Equity?

• A. Shareholders' Equity decreases by $60.
• B. Shareholders' Equity increases by $60.
• C. Shareholders' Equity decreases by $100.
• D. Shareholders' Equity increases by $40.

Answer: (A)

An asset write-down is recorded as an expense, so pretax income drops by the write-down amount. With a 40% tax rate, the tax expense decreases by 40, which means after-tax income falls by 60 (100 less 40). Since net income flows into retained earnings, a portion of shareholders’ equity—the retained earnings—decreases by 60. In other words, the impairment lowers assets by 100 but leaves equity reduced by only 60 due to the tax shield. The net effect on Shareholders' Equity is a decrease of 60.

An asset write-down is recorded as an expense, so pretax income drops by the write-down amount. With a 40% tax rate, the tax expense decreases by 40, which means after-tax income falls by 60 (100 less 40). Since net income flows into retained earnings, a portion of shareholders’ equity—the retained earnings—decreases by 60. In other words, the impairment lowers assets by 100 but leaves equity reduced by only 60 due to the tax shield. The net effect on Shareholders' Equity is a decrease of 60.