Question

A company records a current year depreciation charge of $1,200,000 which ...

A.decreases cash flow from operations by $120,000.

B.decreases net income but not the cash flow of the firm.

C.increases the shareholders' equity by $120,000.

D. increases total assets by $120,000.

Answer 1

Depreciation is an accounts line item and is included in the income statement so as to take advantage of its tax deductibility nature. This essentially means that depreciation is not taxable and hence subtracting the same form a company's operating income reduces its taxable income, thereby resulting in tax savings for the company. Depreciation in now way reflects any real cash flow or expense. Hence, the same is added back to the company's net income while calculating any type of cash flow be it operating or free.

Additionally, yearly depreciation expense (such as given above) and not accumulated depreciation is an income statement item instead of a balance sheet item.

Hence, option (a) is wrong as depreciation does not constitute any real cash inflow/outflow. Opion (c) and Option (d) are also wrong as accumulated and not current year depreciation is included in the balance sheet.

Hence the correct answer is option (b).