If depreciation increases by $10, what happens to the 3 financial statements?



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If depreciation increases by $10, what happens to the 3 financial statements?

2 Answer(s)


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If depreciation increases by $10 then let's start with the balance sheet. In the balance sheet your capital assets will reduce by $10. That is because depreciation is nothing but reducing the value of you capital assets, you capital expenditure year by year. So, if you are increasing the depreciation by $10 then your capital assets in your balance sheet will decrease by the proportional $10. Now number 2- your income statement. In your income statement, depreciation is an operating expense. Hence, if depreciation increases by $10, then your operating expense will increase by $10, which means your operating income and, subsequently, your net income will decrease by $10. Number 3 - your cash flow statement. In your cash flow statement depreciation is what is called a non-cash expense. So, in your cash flow statement depreciation is subtracted, because it is a non-cash expense. Hence, if depreciation increases by $10, then your cash flow will also increase by that $10, because that extra $10 has been subtracted in your income statement as an expense but it is added back in your cash flow statement, since it is not a cash expense. So, your overall cash flow will increase by $10.

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You forgot that your $10 of D&A would be taxed, at say, 40%. This means that net income would decrease by $6. Follow that through to cash flow from operations: net income decreases by $6 and D&A increases by $10, so your cash flow from operations would increase by $4. This would flow through to cash at end of period increase of $4, and subsequently cash in current assets on Balance Sheet increases by $4. Retained earnings calc for the BS would also decrease by $6 (from net income on income statement) and so shareholder equity decreases by $6. PP&E would also decrease by $10 of depreciation. BS therefore balances: net asset decrease of $6 (PP&E -$10 + +4 cash increase), liabilities + shareholder equity decrease of $6 (shareholder equity).