Which statement best describes the impact of depreciation on financial statements?

Which statement best describes the impact of depreciation on financial statements?

• A. Reduces net income and increases accumulated depreciation (non-cash)
• B. Increases cash
• C. Increases net income
• D. Has no effect on the financial statements

Answer: (A)

Depreciation is a non-cash expense that allocates the cost of a long-term asset over its useful life. Recording depreciation lowers reported net income on the income statement because it increases expenses. At the same time, it does not involve an actual cash outlay, so cash in the period is unaffected. On the balance sheet, accumulated depreciation (a contra-asset) increases over time, which reduces the asset’s net book value. Because it lowers net income, does not change cash directly, and increases accumulated depreciation, this description best captures depreciation’s impact on financial statements. The other options miss one or more of these effects: cash is not increased, net income is reduced (not increased), and depreciation does affect the financial statements.

Depreciation is a non-cash expense that allocates the cost of a long-term asset over its useful life. Recording depreciation lowers reported net income on the income statement because it increases expenses. At the same time, it does not involve an actual cash outlay, so cash in the period is unaffected. On the balance sheet, accumulated depreciation (a contra-asset) increases over time, which reduces the asset’s net book value. Because it lowers net income, does not change cash directly, and increases accumulated depreciation, this description best captures depreciation’s impact on financial statements. The other options miss one or more of these effects: cash is not increased, net income is reduced (not increased), and depreciation does affect the financial statements.