After Depreciation, which describes the Balance Sheet changes?

After Depreciation, which describes the Balance Sheet changes?

• A. PP&E decreases by $10 and Cash increases by $4
• B. PP&E decreases by $10 and Cash decreases by $10
• C. PP&E unchanged and Cash unchanged
• D. PP&E increases by $10 and Cash decreases by $4

Answer: (A)

Depreciation reduces the book value of fixed assets and also creates a tax shield because it lowers taxable income. On the balance sheet, this shows up as a lower PP&E by the depreciation amount, and, because taxes are saved, cash increases by the tax shield amount. If depreciation is 10 and the tax rate is 40%, the cash increase is 4 (10 × 0.40). So the balance sheet changes would be PP&E down by 10 and cash up by 4. The other options either show cash moving in the wrong direction or misstate the asset value.

Depreciation reduces the book value of fixed assets and also creates a tax shield because it lowers taxable income. On the balance sheet, this shows up as a lower PP&E by the depreciation amount, and, because taxes are saved, cash increases by the tax shield amount. If depreciation is 10 and the tax rate is 40%, the cash increase is 4 (10 × 0.40). So the balance sheet changes would be PP&E down by 10 and cash up by 4. The other options either show cash moving in the wrong direction or misstate the asset value.