Depreciation is a non-cash expense; its effect on the balance sheet is to:

Depreciation is a non-cash expense; its effect on the balance sheet is to:

• A. Reduce PP&E and increase cash flow
• B. Increase PP&E and reduce cash flow
• C. Increase cash and increase liabilities
• D. Reduce cash and increase equity

Answer: (A)

Depreciation is a non-cash expense, so it lowers reported income without using cash. The balance sheet effect comes from accumulated depreciation, a contra-asset account that increases over time and reduces net PP&E. So net PP&E decreases. At the same time, the depreciation deduction reduces taxable income, lowering taxes and boosting cash flow from operations, which increases the cash the company holds. Put together, depreciation reduces PP&E (net) and increases cash flow, which is the best description of its balance sheet and cash flow impact.

Depreciation is a non-cash expense, so it lowers reported income without using cash. The balance sheet effect comes from accumulated depreciation, a contra-asset account that increases over time and reduces net PP&E. So net PP&E decreases. At the same time, the depreciation deduction reduces taxable income, lowering taxes and boosting cash flow from operations, which increases the cash the company holds. Put together, depreciation reduces PP&E (net) and increases cash flow, which is the best description of its balance sheet and cash flow impact.