In relation to the Cash Flow Statement, what does depreciation represent?

• A. A cash expense incurred by the company
• B. A non-cash expense adjustment
• C. A reduction in operating cash flow
• D. An increase in tax liabilities

Answer: (B)

Depreciation represents a non-cash expense adjustment on the Cash Flow Statement. It is an accounting method used to allocate the cost of tangible assets over their useful lives. Although depreciation reduces the taxable income reported on the income statement, it does not involve actual cash outflow during the period in which it is recorded. Instead, it serves to reflect the wear and tear or usage of assets, allowing companies to match the expense of an asset to the revenue it generates over time.

In terms of cash flow, it is added back to the net income in the operating activities section of the Cash Flow Statement. This adjustment acknowledges that while depreciation reduces reported earnings, it does not correspond to an equivalent cash expense. Thus, recognizing it as a non-cash expense is essential for understanding the true cash-generating capacity of the business.