In Year 3, with Book Depreciation of 10 and Tax Depreciation of 5, what is the Net Income change on the Book vs Tax statements and the Cash Taxes impact?

In Year 3, with Book Depreciation of 10 and Tax Depreciation of 5, what is the Net Income change on the Book vs Tax statements and the Cash Taxes impact?

• A. Book NI down 6; Tax NI down 3; Cash Taxes down 2; CFO from operations up by 2
• B. Book NI down 6; Tax NI down 3; Cash Taxes up by 2; CFO from operations down by 2
• C. Book NI down 3; Tax NI down 6; Cash Taxes down by 2; CFO from operations up by 4
• D. Book NI down 6; Tax NI down 3; Cash Taxes down by 6; CFO from operations up by 8

Answer: (A)

Timing differences between book and tax depreciation affect both after-tax income and cash taxes. With depreciation that is higher for book purposes (10) than for tax purposes (5), the same change in pretax income creates a larger after-tax drop on the book side. Using a 40% tax rate (as implied by the numbers), the after-tax effect on net income is depreciation times (1 − tax rate). For book depreciation of 10, net income falls by 10 × 0.60 = 6. For tax depreciation of 5, net income falls by 5 × 0.60 = 3. So Book NI down 6 and Tax NI down 3. Cash taxes paid are affected by the current-year tax deduction amount. The tax payment is reduced by 40% of the depreciation difference, i.e., 0.40 × 5 = 2. That means cash taxes are down by 2, which boosts cash flow from operations by 2. So the pattern is: Book NI down 6; Tax NI down 3; Cash Taxes down by 2; CFO from operations up by 2. The other options would require inconsistent signs for either the NI amounts, the cash taxes, or the CFO impact.

Timing differences between book and tax depreciation affect both after-tax income and cash taxes. With depreciation that is higher for book purposes (10) than for tax purposes (5), the same change in pretax income creates a larger after-tax drop on the book side.

Using a 40% tax rate (as implied by the numbers), the after-tax effect on net income is depreciation times (1 − tax rate). For book depreciation of 10, net income falls by 10 × 0.60 = 6. For tax depreciation of 5, net income falls by 5 × 0.60 = 3. So Book NI down 6 and Tax NI down 3.

Cash taxes paid are affected by the current-year tax deduction amount. The tax payment is reduced by 40% of the depreciation difference, i.e., 0.40 × 5 = 2. That means cash taxes are down by 2, which boosts cash flow from operations by 2.

So the pattern is: Book NI down 6; Tax NI down 3; Cash Taxes down by 2; CFO from operations up by 2. The other options would require inconsistent signs for either the NI amounts, the cash taxes, or the CFO impact.