Depreciation expense is a non-cash charge. Which statement best describes its effect on net income and cash flow in the period recognized?

• A. Depreciation reduces cash flow in the period it is recognized.
• B. Depreciation reduces net income but does not affect cash flow from operations in the period it is recognized.
• C. Depreciation increases cash flow due to tax savings.
• D. Depreciation has no impact on net income or cash flow.

Answer: (B)

Depreciation is a non-cash expense, meaning it reduces reported earnings without requiring a cash outlay in that period. So the amount of depreciation lowers net income, but it does not actually reduce cash flow from operations in the period it’s recognized. When preparing the cash flow from operations under the indirect method, depreciation is added back to net income to reconcile to cash provided by operations, which is why the non-cash nature of depreciation does not shrink operating cash flow in that period. The main takeaway is that depreciation lowers net income, but the cash impact in the period is tied to the non-cash nature of the charge and the tax shield is not the immediate effect described here.