Following the depreciation change, what happens to Shareholders' Equity and Net Income?

Following the depreciation change, what happens to Shareholders' Equity and Net Income?

• A. Decreases by $6
• B. Increases by $6
• C. Unchanged
• D. Decreases by $10

Answer: (D)

Depreciation is an expense. When depreciation changes upward, expenses rise, so profit (net income) drops by that amount. Net income feeds into retained earnings, which is part of Shareholders’ Equity, so a lower net income reduces Shareholders’ Equity by the same amount. In this case, the depreciation change lowers Net Income by 10 and, through retained earnings, lowers Shareholders’ Equity by 10. (If you’re accounting for taxes, the net income drop would be depreciation multiplied by (1 minus the tax rate).)

Depreciation is an expense. When depreciation changes upward, expenses rise, so profit (net income) drops by that amount. Net income feeds into retained earnings, which is part of Shareholders’ Equity, so a lower net income reduces Shareholders’ Equity by the same amount. In this case, the depreciation change lowers Net Income by 10 and, through retained earnings, lowers Shareholders’ Equity by 10. (If you’re accounting for taxes, the net income drop would be depreciation multiplied by (1 minus the tax rate).)