Depreciation expense has which effect on the financial statements?

• A. It reduces net income via depreciation expense and reduces asset value through accumulated depreciation.
• B. It increases cash available.
• C. It increases the reported asset value.
• D. It has no effect on the income statement.

Answer: (A)

Depreciation expense recognizes the cost of a tangible asset over its useful life. Recording it lowers net income on the income statement because expenses reduce earnings. At the same time, it increases accumulated depreciation, a contra-asset on the balance sheet, which reduces the asset’s carrying value. Since depreciation is a non-cash expense, it does not actually decrease cash in the period, though it affects cash flows when preparing the cash flow statement. So the effect is: lower net income and a lower book value for the asset through accumulated depreciation.