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

• A. Increases assets and equity
• B. Increases cash and increases revenue
• C. Decreases net income and decreases owner's equity
• D. Increases expenses and reduces net income; increases accumulated depreciation

Answer: (D)

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.