Depreciation's Impact on Net Income

Summary

Although Depreciation & Amortization (D&A) is a non-cash expense, it reduces Net Income reported on the Income Statement because it is treated as an operating expense. However, the reduction is partially offset by tax savings.

Mechanism:

1. Expense Recognition: D&A is recorded as an expense, typically within COGS or Operating Expenses, lowering EBIT and Pre-Tax Income (EBT).
2. Tax Deductibility: D&A is tax-deductible, meaning it reduces the amount of income subject to taxes.
3. Tax Shield: The reduction in taxable income results in lower Tax Expense compared to a scenario without depreciation. This tax saving is known as the depreciation “Tax Shield”.
4. Net Income Effect: The overall impact on Net Income is a decrease equivalent to: $Depreciation\times (1-TaxRate)$. Net Income falls, but by less than the full D&A amount due to the tax savings.

Cash Impact

While Net Income decreases, the actual cash impact is positive due to the tax savings ($Depreciation\times TaxRate$), as the non-cash D&A expense is added back on the Cash Flow Statement.

---

See also: Depreciation & Amortization (D&A), Non-Cash Expenses, Income Statement, Tax Shield