What is the effect of recording depreciation on a company’s net income?

What is the effect of recording depreciation on a company’s net income?

• A. Increases net income
• B. No effect on net income
• C. Decreases net income
• D. Varies based on asset type

Answer: (C)

Recording depreciation decreases a company's net income. This occurs because depreciation is considered an expense that is deducted from total revenue when calculating net income. When a company purchases a long-term asset, it does not immediately deduct the full cost of the asset as an expense; rather, it spreads that cost over the useful life of the asset through depreciation. Each period, a portion of the asset's cost is recognized as depreciation expense, thereby lowering the profit reported for that period. Since net income is derived by subtracting total expenses (including depreciation) from total revenues, an increase in depreciation expense directly reduces net income. This effect is important as it provides a more accurate picture of a company's profitability by reflecting the ongoing costs associated with using long-term assets. Focusing on the other choices, increasing net income would imply that expenses are lower, while having no effect would suggest that depreciation is not recognized in the income statement at all, both of which do not apply. Furthermore, suggesting that the effect varies based on asset type overlooks the consistent accounting treatment of depreciation as an expense across all assets.

Recording depreciation decreases a company's net income. This occurs because depreciation is considered an expense that is deducted from total revenue when calculating net income. When a company purchases a long-term asset, it does not immediately deduct the full cost of the asset as an expense; rather, it spreads that cost over the useful life of the asset through depreciation. Each period, a portion of the asset's cost is recognized as depreciation expense, thereby lowering the profit reported for that period.

Since net income is derived by subtracting total expenses (including depreciation) from total revenues, an increase in depreciation expense directly reduces net income. This effect is important as it provides a more accurate picture of a company's profitability by reflecting the ongoing costs associated with using long-term assets.

Focusing on the other choices, increasing net income would imply that expenses are lower, while having no effect would suggest that depreciation is not recognized in the income statement at all, both of which do not apply. Furthermore, suggesting that the effect varies based on asset type overlooks the consistent accounting treatment of depreciation as an expense across all assets.