The first thing that needs to be said about the impact of depreciation expense on the cash flow

analysis of a capital project is that depreciation expense has a direct effect on the profit of a
company (Merritt, 2019). Hence, the larger the depreciation expense, the lower the net income
reported by the company.

Knowing that businesses get taxed based on their profits, it is safe to assume that it is much more
preferable for any given company to use the depreciation method with an accelerated schedule,
rather than the straight-line depreciation method which requires no upfront reporting of expense, but
gradual depreciation of expense each year for many years.

Hence it appears that moving most of the depreciation to the earliest years of the asset’s useful life
results in a larger expense in those years, which in turn leads to lower profits and, therefore, to a
lower tax in the early years.

Leasing arrangements should be considered in terms of depreciation expense as well. The following
are the types of leases:
- Financial lease;
- Operating lease;
- Sale and lease back leasing;
- Sales aid lease;
- Specialized Service Lease;
- Small Ticket and Big Ticket Leases;
- Cross border leases.

Explained simply, the most important advantage of leasing is its flexibility (Chand, n.d.). Leasing
process requires less documentation and most of the times is considered as an alternative source to
obtain loan as well as other facilities for manufacturing. One more advantage is that a leasing
company may provide the full amount (100%) financing for the cost of equipment, whereas banks
and other financial institutions seldom do the same. Moreover, a lessee may avail tax benefits
depending upon his tax status.

However, apart from advantages there are certain disadvantages of leasing:

- Higher cost of interest;
- No residual value for an asset after it reverts back to the lessor;
- Rentals become payable soon after the acquisition of assets;
- Higher risk of an asset being seized by the bank, in case of the lessor default.

Word count: 350.

References:
Chand, S (n.d.). Leasing: Definitions, Types, Merits and Demerits. Retrieved from
http://www.yourarticlelibrary.com/law/leasing-definitions-types-merits-and-demerits/23516
Merritt, C. (2019, January 11). What Is the impact of depreciation expense on profitability? Retrieved
from https://smallbusiness.chron.com/impact-depreciation-expense-profitability-55349.html