Tax

Study: Bonus Depreciation Boosts Cash Flows

Some companies are enjoying a temporary increase in operating cash as result of the tax benefit tied to the government's accelerated depreciation p...
Marie LeoneApril 13, 2009

The temporary boost to operating cash spurred by the bonus depreciation deduction enacted  last year just starting to show up on corporate financial statements. Some companies are benefiting mightily, according to a new study by RiskMetrics Group.

At least for now. The temporary bump in cash flow companies are getting by deferring tax payments will reverse over time – albeit at a slower pace and, perhaps, when the economy has improved a bit.

The bonus depreciation deduction, which was passed in 2008 as part of the Economic Stimulus Act, was extended for another year in February, when the American Recovery and Reinvestment Act of 2009 (ARRA) was signed into law. The aim of the provisions have been to encourage companies to increase spending on major pieces of equipment by allowing them to accelerate the depreciation of long-lived or capital assets.

Drive Business Strategy and Growth

Drive Business Strategy and Growth

Learn how NetSuite Financial Management allows you to quickly and easily model what-if scenarios and generate reports.

Specifically, companies are allowed to claim a deduction equal to 50% of the cost of a qualified asset. A qualified asset is a piece of capital equipment that has been bought and put into service in the year in which the bonus applies. The deferred tax payments are spread out over the remaining life of the asset, starting in year two. The other 50% of the asset’s cost is subject to the regular depreciation schedule set by the Internal Revenue Service. To qualify for the 2009 deduction, companies must buy the equipment and put it into service, before Jan. 1, 2010.

While the bonus deduction is temporary, that’s a small price to pay for what can be a considerable increase in cash flow, according to study author Zhen Deng, a RiskMetrics analyst. She calls the bonus depreciation deduction a government-sponsored “freebie,” that is especially useful during a credit crunch when many companies are fighting off liquidity problems. She also explains that the deduction is “a pure tax play,” meaning that it does not affect net income or earnings.

Rather, the deduction is a “timing issue,” says Deng, referring to the opportunity companies have to postpone their tax payment. “Considering the time value of money, deferring cash payments – even when there is not a liquidity crunch – is always a good thing.”

The research company worked up two metrics to illustrate the effects of the deduction, according to Deng. The report looks at a ratio that compares the estimated cash benefit of the deduction to a company’s capital expenditures. In addition, it examines a ratio that compares the cash benefit to operating cash flow.

Finding the companies to examine were a challenge, says Deng. “You can see signs but you cannot be certain” which companies claimed a bonus deduction unless it is revealed in the financial statement footnotes, she told CFO.com.

The study highlighted 10 companies that quantified the impact of the bonus depreciation in their 2008 financial statements, including CSX Corporation, Ryder System, and Southwest Gas. For example, CSX has a 6% cash-benefit-to-operating cash-flow ratio, which means that for every $100 the railroad company reports in operating cash flow, $6 is attributable to tax savings.

Similarly, a 9% cash benefit-to-capital-expenditure ratio means that for every $100 of reported capex, CSX gets $9 of tax savings. Meanwhile, Southwest Gas came in at 8% in both categories, with Ryder System registering 6% in each category. Utility company Vectren has a 13% cash- benefit-to-capex ratio, the highest of the group, while at 22%, OGE Energy has the highest cash benefit-to-cash flow ratio.

The study also named 16 other companies that will likely benefit from the 2008 deduction, identified by criteria that make the companies good candidates for claiming the deduction. That group includes Comcast, Fluor, Pactiv, and PepsiCo, all companies that carried a deferred tax liability and recorded more than 10% increase in its DTL in 2008 but did not record a corresponding increase in capital expenditures. Further, all of the companies attributed a significant portion of the hike in DTL to either depreciation or property, plant and equipment.

Of the group of 16, the study gleaned enough information from financial statements to estimate the cash benefit as compared to the operating cash flow. Comcast had the highest ratio at 7%, while Pepsi was flat at 0%. Both Iron Mountain and Pactiv came in at 5%.

 

4 Powerful Communication Strategies for Your Next Board Meeting