Question

What happens if you misstate depreciation in your model? It should be $10 million higher.

a) Overstated Expenses
b) Understated Expenses
c) No Impact on Financials
d) Improved Profit Margins

Answer 1

Misstating depreciation by $10 million too low results in understated expenses and an appearance of improved profit margins due to higher reported net income.

Step-by-step explanation:

If depreciation is misstated in your model by being $10 million too low, this would lead to understated expenses. Depreciation is an expense that reduces pre-tax income, so if it is not accounted for accurately, expenses will be understated. As a consequence, the net income would incorrectly appear higher than it should.

This would also incorrectly suggest improved profit margins, as the profit margin ratio is calculated by dividing net income by revenue. Higher net income, due to lower expenses from the understated depreciation, would give the impression of better profitability.