### CFA Practice Question

A firm's accountant has mistakenly overstated depreciation by 50 and understated accounts receivables by 35. The firm's tax rate is 40%. Then, which of the following is (are) true?

I. Income is understated by 30.
II. Income is understated by 50.
III. Operating cash flow is overstated by 55.
IV. Operating cash flow is overstated by 85.
A. I and IV.
B. II and III.
C. I and III.
Explanation: If depreciation is overstated by 50, the income is actually understated by 50*(1-tax rate) = 30. The understatement of accounts receivables does not affect the income statement; it understates the reported current assets. It also affects the operating cash flow. Note that operating cash flow = net income + noncash expenses - non-cash revenues - cash reductions in operating accounts Since income is understated by 30, non-cash expense (depreciation) is overstated by 50 and non-cash revenue (accounts receivable) is understated by 35, operating cash flow is overstated by -30 + 50 - (-35) = 55.