What is the effect of depreciation on financial statements?

• A. Increases net income.
• B. Not affecting financial statements.
• C. Decreases net income and increases accumulated depreciation.
• D. Increases asset value.

Answer: (C)

Depreciation spreads the cost of a long-lived asset over its useful life. It is recorded as an expense on the income statement, so it lowers the period’s net income. On the balance sheet, depreciation increases accumulated depreciation, a contra-asset account, which reduces the asset’s net book value. Because this is a non-cash expense, it doesn’t involve an immediate cash outflow, but it does reduce profitability and the carrying value of assets. So the effect on financial statements is that net income decreases and accumulated depreciation increases. It does not increase asset value.