Write Down of PPE by 100
May seem like a basic question, but still confused. Let's say PPE is written down by 100. EBIT will decrease by 100, and after tax effect is -60 on NI. Once we move to cash flow statement, we add back the 100, and we have a net change of +40 cash.
But let's just stop and think about it. Does a PPE write off really increase cash? My point of confusion is that we should also take into account the DTA that is created when our book pre tax income is lower than our taxable income. In this case, the DTA created is 40, instead of cash going up by 40.
Hi Wharton,
Here is how I recommend you conceptualize it:
The positive change in cash on the CF statement isn't saying that you "got" more cash. It's saying that when viewing this transaction in isolation, you are paying $40 less cash to the IRS because of the write-down. Your cash is "going up" not because cash was added to your bank account, its that you sent less cash to the government (this does assume immediate deductibility). Net effect is the same, your cash balance goes up.
Now, if you want to go deeper and consider deferred taxes, see below. Though note that this is really technical and I would not discuss this in an interview unless pressed.
The write-down will not be deductible for tax purposes immediately, so you need a DTA which would create a deferred tax benefit on the income statement. However, you would also need to increase current tax expense and taxes payable to reflect the fact that the write-down would be reversed in computing taxable income. So, as you can see, tax expense is actually unchanged due to this impairment in the year of the impairment (current and deferred taxes cancel each other out)!! Going back to the CF statement, the deferred tax benefit would be subtracted, and the increase in taxes payable would be added back. Additionally, your net income is actually not -$60, it's -$100 because in the real world, tax expense would be unchanged in the year of the impairment -- so after making the deferred tax benefit, taxes payable, and non-cash impairment adjustment, you end up with zero change in cash. Hopefully this feels more intuitive. If no impairment existed, there would have been zero taxes due (assuming nothing else happened that year). If the impairment did exist, you would have net income of -$100, then the impairment would be added back in computing taxable income yielding $0 in taxable income. So, still no taxes due. Hence, no change in cash due to this transaction relative to the baseline.
Hope that helps.