Which statement about depreciation and cash flow is true?

Which statement about depreciation and cash flow is true?

• A. It has no cash tax effect
• B. It reduces cash taxes
• C. It increases cash tax payments
• D. GAAP depreciation has no direct cash tax effect

Answer: (D)

Depreciation on financial statements (GAAP) is a non-cash expense that lowers reported net income but does not directly change the actual cash taxes you pay. The cash tax you owe is determined by the tax depreciation allowed by tax rules, which is typically different from GAAP depreciation. Because GAAP depreciation isn’t used to calculate taxes, it doesn’t have a direct cash tax effect; any impact on cash taxes comes through the tax depreciation (and potential timing differences that show up as deferred taxes). That’s why the statement about GAAP depreciation having no direct cash tax effect is the best choice.

Depreciation on financial statements (GAAP) is a non-cash expense that lowers reported net income but does not directly change the actual cash taxes you pay. The cash tax you owe is determined by the tax depreciation allowed by tax rules, which is typically different from GAAP depreciation. Because GAAP depreciation isn’t used to calculate taxes, it doesn’t have a direct cash tax effect; any impact on cash taxes comes through the tax depreciation (and potential timing differences that show up as deferred taxes). That’s why the statement about GAAP depreciation having no direct cash tax effect is the best choice.