If the estimated life of a long-term asset is increased, which of the following is true?
I. The depreciation expense increases
II. Taxes decrease -
III. Income increases -
IV. Cashflow decreases -
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A. B. C. D.B
The increase in the asset's life estimate decreases the depreciation expense. Hence, income increases, taxes increase and cashflow decreases (due to higher taxes).
When the estimated life of a long-term asset is increased, the correct options are A. I & II: "The depreciation expense increases" and "Taxes decrease."
I. The depreciation expense increases: Depreciation is the process of allocating the cost of a long-term asset over its useful life. By increasing the estimated life of the asset, the depreciation expense will be spread out over a longer period. This means that the annual depreciation expense will be smaller since the cost is allocated over a larger number of years. However, it's important to note that while the annual depreciation expense decreases, the total depreciation expense over the entire life of the asset remains the same.
II. Taxes decrease: Taxes are generally calculated based on the taxable income, which is the income after deducting allowable expenses, including depreciation. When the estimated life of an asset is increased, the annual depreciation expense decreases, resulting in higher taxable income. Consequently, the tax liability also increases. Therefore, the statement that taxes decrease is incorrect. The correct option should be A. I & II.
III. Income increases: Increasing the estimated life of a long-term asset will decrease the annual depreciation expense. As a result, the expense deducted from the revenue decreases, leading to a higher net income. Therefore, the statement that income increases is correct.
IV. Cashflow decreases: Cash flow refers to the actual inflows and outflows of cash. When the estimated life of an asset is increased, it does not directly impact cash flow. Cash flow depends on factors such as revenue, expenses, investments, and financing activities. The change in estimated life does not affect the cash inflows or outflows. Therefore, the statement that cash flow decreases is incorrect. The correct option should be A. I & II.
To summarize, when the estimated life of a long-term asset is increased: