Fundamentals of Accountancy, Business, and Management (FABM) 1 Practice Exam

What is the effect of recording depreciation expense on the financial statements?

Increases assets and equity

Increases cash and increases revenue

Decreases net income and decreases owner's equity

Increases expenses and reduces net income; increases accumulated depreciation

Depreciation expense allocates part of an asset’s cost to the current period. It increases the depreciation expense on the income statement, which lowers net income. Because net income is linked to owners’ equity through retained earnings, lower net income reduces equity. On the balance sheet, depreciation accumulates in accumulated depreciation, a contra-asset account, which increases and reduces the asset’s net book value. Since depreciation is a non-cash expense, it does not increase cash. So the recording effect is: higher expenses, lower net income, and higher accumulated depreciation.