Exploring What Pair of Financial Statements Show Depreciation Expense

Introduction

Depreciation expense is an accounting concept that refers to the decrease in value of a business’s fixed assets over time due to wear and tear, obsolescence, or other factors. It is a non-cash expense, meaning it does not involve a payment from the company, but instead is used to reduce the amount of taxable income reported by the company. Understanding how depreciation expense affects a company’s financial statements is essential for making informed decisions about investments and managing finances.

Exploring the Impact of Depreciation Expense on Financial Statements

The impact of depreciation expense on a company’s financial statements can be seen in both the balance sheet and the profit & loss statement. Let’s take a closer look at how depreciation expense affects each.

Balance Sheet

On the balance sheet, depreciation expense reduces the amount of assets reported by the company, while increasing the amount of liabilities reported. This is because depreciation expense is recorded as an expense on the income statement, which reduces the amount of revenue reported, which in turn reduces the amount of retained earnings reported on the balance sheet. The reduction in assets is offset by an increase in liabilities, since the amount of depreciation expense must be matched by an equal amount of reserves on the balance sheet.

For example, if a company has an asset with a book value of $100 and records $10 of depreciation expense in a given year, then the asset’s book value would be reduced to $90. This $10 reduction in assets would be offset by a $10 increase in liabilities, since the amount of depreciation expense must be matched by an equal amount of reserves on the balance sheet.

Profit & Loss Statement

On the profit & loss statement, depreciation expense reduces the amount of revenue reported by the company, while increasing the amount of costs reported. This is because depreciation expense is recorded as an expense on the income statement, which reduces the amount of net income reported. The reduction in revenue is offset by an increase in costs, since the amount of depreciation expense must be matched by an equal amount of expenses.

For example, if a company has $100 of revenue and records $10 of depreciation expense in a given year, then the company’s net income would be reduced to $90. This $10 reduction in revenue would be offset by a $10 increase in costs, since the amount of depreciation expense must be matched by an equal amount of expenses on the profit & loss statement.

Analyzing the Impact of Depreciation Expense on Financial Statements

In order to fully understand the impact of depreciation expense on financial statements, there are several factors to consider. First, there are different methods for calculating depreciation expense. According to the Internal Revenue Service (IRS), the most common methods are straight-line, declining balance, and sum-of-the-years’ digits.

Second, there are differences in the way different companies account for depreciation expense. Some companies may choose to record depreciation expense as an expense on the income statement, while others may choose to record it as an adjustment to the balance sheet. Additionally, some companies may choose to record depreciation expense on a monthly basis, while others may choose to record it annually.

Finally, it is important to understand the role of depreciation expense in financial statements. By understanding how depreciation expense affects the balance sheet and profit & loss statement, investors and financial managers can make more informed decisions about investments and managing finances.

Conclusion

Depreciation expense is an important concept that affects financial statements. On the balance sheet, depreciation expense reduces the amount of assets reported by the company, while increasing the amount of liabilities reported. On the profit & loss statement, depreciation expense reduces the amount of revenue reported by the company, while increasing the amount of costs reported.

When analyzing the impact of depreciation expense on financial statements, it is important to consider different methods for calculating depreciation expense, differences in the way different companies account for depreciation expense, and the role of depreciation expense in financial statements. By understanding how depreciation expense impacts financial statements, investors and financial managers can make more informed decisions about investments and managing finances.