Question

If Delta decides to utilize this method this will decrease their taxable income which in return means their net income will be lower. Class, why would Delta want to decrease their net income, as their potential and current shareholders may not like this? What are your thoughts?

Class, in the past I have had some students think that Delta should incorporate double declining balance as their depreciation method so they can get the expense of the depreciation up front. If Delta decides to utilize this method this will decrease their taxable income which in return means their net income will be lower. Class, why would Delta want to decrease their net income, as their potential and current shareholders may not like this? What are your thoughts?

Answer 1

Adoption of double declining method would lower the taxable profits. Delta might want to decrease their net income to defer tax payment. With lower taxable profits, the tax liability would also be low and hence there be lesser cash outflow on account of taxes (though the liability would arise in future once the asset if fully depreciated faster in double declining method).

Even though potential and current shareholders may not like lower profits, but in actual the decrease in profits is due to depreciation which is a non-cash expense. Depreciation does not result in any actual cash outflow but is only a wear and tear of asset. Hence, when the shareholders would look at the balance sheet from the point of view of cash surplus there would be no impact (as depreciation is added back while computing cash surplus).