A firm's accountant has mistakenly overstated depreciation by 50 and understated accounts receivables by 35. The firm's tax rate is 40%. Then, which of the following is/are true?
I. Income is understated by 30.
II. Income is understated by 50.
III. Operating cash flow is overstated by 55.
IV. Operating cash flow is overstated by 85.
Click on the arrows to vote for the correct answer
A. B. C. D.C
If depreciation is overstated by 50, the income is actually understated by 50*(1-tax rate) = 30. The understatement of accounts receivables does not affect the income statement; it understates the reported current assets. It also affects the operating cash flow. Note that operating cash flow = net income + noncash expenses - non-cash revenues - cash reductions in operating accounts Since income is understated by 30, non-cash expense (depreciation) is overstated by 50 and noncash revenue (accounts receivable) is understated by 35, operating cash flow is overstated by -30 + 50 - (-35) = 55.