If you include depreciation on Year One, but not in Year Two, how will this affect Year Two net income on financial statements?

If you include depreciation on Year One, but not in Year Two, how will this affect Year Two net income on financial statements?

• A. Net Income Will Be Lower Than It Should Be
• B. Net Income Will Be Unchanged
• C. Net Income Will Be Misstated With Higher Taxes
• D. Net Income Will Be Greater Than It Should Be

Answer: (D)

Depreciation spreads the cost of long‑term assets over their useful life as an expense. In accrual accounting, expenses reduce net income in the period they’re recognized. If depreciation is recorded in Year One but not in Year Two, Year Two will have fewer expenses than it should. That makes Year Two’s pretax income—and thus net income—appear higher than the true figure, so Year Two net income will be greater than it should be. (Taxes would also be affected, but the main point is the net income overstatement.)

Depreciation spreads the cost of long‑term assets over their useful life as an expense. In accrual accounting, expenses reduce net income in the period they’re recognized. If depreciation is recorded in Year One but not in Year Two, Year Two will have fewer expenses than it should. That makes Year Two’s pretax income—and thus net income—appear higher than the true figure, so Year Two net income will be greater than it should be. (Taxes would also be affected, but the main point is the net income overstatement.)