Posted: April 24th, 2016

# Why does the net income not equal net cash flow?

Problem 8-2: Depreciation as a Tax Shield
The term tax shield refers to the amount of income tax saved by deducting depreciation for income tax purposes. Assume that Supreme Company is considering the purchase of an asset as of January 1, 2012. The cost of the asset with a five-year life and zero residual value is \$100,000. The company will use the straight-line method of depreciation.

Supreme’s income for tax purposes before recording depreciation on the asset will be \$50,000 per year for the next five years. The corporation is currently in the 35% tax bracket.

Calculate the amount of income tax that Supreme must pay each year if the asset is not purchased. Calculate the amount of income tax that Supreme must pay each year if the asset is purchased. What is the amount of the depreciation tax shield?

PROBLEM 8-4: Depreciation and Cash Flow
O’Hare Company’s only asset as of January 1, 2012, was a limousine. During 2012, only three transactions occurred: Services of \$100,000 were provided on account; All accounts receivable were collected; Depreciation on the limousine was \$15,000.

1. Develop an income statement for O’Hare Company for 2012.
2. Determine the amount of net cash flow for 2012.
3. Why does the net income not equal net cash flow?
4. If O’Hare developed a cash flow statement for 2012 using the indirect method, what amount would appear in the category titled Cash Flow from Operating Activities?

EXERCISE 9-5: Current Liabilities and Ratios

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