Effect of Depreciation Business functions
Cash flow—if it is used for tax purposes then declining-balance (DB) method is proffered because early tax deduction provides better result than later tax deduction. Under DB depreciation expense method Highest depreciation is deducted; therefore, lower taxable income is yield, that’s why lower income tax payable (and lower cash outflow) in the early years and in later year case reverse. Beside cash outflows used for taxes, any method chosen by the management has no cash flows. That’s why there is always option for company to use different methods i.e. separate for tax purpose and financial reporting.
Fixed asset turnover– DB method is the favorable method in case of fixed asset turnover, as it concludes in highest amount of depreciation expense in earlier year which result in low values of net fixed assert, and in later years the case is reverse and it results in lowest fixed assert turnover
EPS-straight line method is most favorable method, as straight line method of depreciation yields the lowest amount of depreciation in begging year as compare to other depreciation method which result in highest EPS in earlier year, in later year reverse is the case and it will result the low EPS in later year
Recommendation to General Motors’ management- As the option lies with their company to chose different methods for both purposes i.e. tax and accounting purpose so it should chose different method for both purpose, the best way to reduce the taxes in 1 year is to use double deckling method, and for financial reporting straight line depreciation method is best purpose serve because it gives highest EPS in initials years. With passage of time like in second year comparative advantages of one method over the other reverse, But as per accounting standard accounting method should be same in every year as company is bound to follow the same method initially chosen. Reasonable justification is required to change methods in future