Tuesday, June 9, 2009

GAAP Depreciation and Paying Higher Taxes Makes You More Bankable?

I just completed a review of a client's financial statements. Or so I thought because the bank then had an unusual request.

The financial statements were issued on the income tax basis of accounting as opposed to generally accepted accounting principles ("GAAP"). The only real difference here was depreciation - the Company does not keep a separate, GAAP set of depreciation records. The Company has in excess of 750 individually tracked assets. They use an outstanding depreciation software program (the same one we use in our practice) and could do it, but they prefer not to. The big difference is that they record bonus depreciation and basis reductions for financial reporting purposes.

Then they complicated things a bit further. During 2008, the Company engaged consultants to perform a cost segregation study. Essentially, engineers examined their buildings and said something like 40% of the costs are of the type that can be depreciated over 7 years instead of over 39 years, and 25% can be depreciated over 15 years, and so on.

The result is a dramatic acceleration of depreciation charges. The pick up in depreciation in 2008 included depreciation adjustments for prior years as well. The Company reported a loss purely as a result of this non cash charge. From an operating standpoint, they generated plenty of cash from operations.

Their bank, however, totally could not understand this. They had to know what depreciation would have been under GAAP. Because otherwise their analysts couldn't compute their typical ratios on the Company!

Let's see: the Company had significant depreciation charges. Those became a deduction against taxable income. Which in turn means the Company had lower taxable income and therefore could retain more cash that otherwise would have gone to the government. And retaining more cash means they had more money to repay the bank!

But no, the analysts said "please tell us what GAAP depreciation would have been so the Company can be more bankable."

They apparently don't get it.

Are there any bankers out there reading this who would have handled this differently? Because this just doesn't make sense to me.

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