Hi all, everything affects Balance sheet two times (both sides of BS or single side), such as:
-When you invest in a bond: increse Bond, decrease Money (sum of Assets, Liabilities and Equity unchanged)
-When you buy a Machine by Loan: increase Machine, increase Loans payble (sum of Assets and Liabilities increase, Equity unaffected-BS still balanced)
But, when Amortization, the increase of Expense on Income statement and the decrease of that Machine on Balance sheet makes the Balance sheet imbalance.
Thank you for your response, but slightly weird, though many sources of information have that same idea,
IMO, Net income but also Retained earnings are messed up by many other components like tax and many other expenses.
A different perspective is-it is added back to the amount of money via CF statement (because of the non-cash nature), and increases the money by the amount of Depriciation (which makes Assets, Liabilities and Equity unchanged).
Mikey is correct. (Mikey is always correct).
On a tangent, have you ever heard of EBITDA? (Earnings Before Interest, Taxes, Depreciation, and Amortization.) Net income shows total earnings after those costs are subtracted.
I would saying going to this depends on how comfortabl eyou are with accounting.
Cash flow statements - these explain how cahs on the balance sheet chnage. They also split this into 3 areas so we can make sense of what we are doing.
If you think about the balance sheet if we are explain how cash changes we are also then explaining how every other item on the balance sheet changes.
Chnage in cash = Net Chnage in all other assets and liabilities.
CFO - Looks at the effect retained earnings and working capital
We add detail on here to make it useful we don’t just do change in retained earnngs but should net icnome and chnages in working capital
CFI - looks at chnage in fixed assets
CFF - Chnage in financing other components of equity and chnages in debt.
Depreciation is reverses from net income so we are only think about cash flow. Likewise gaiin/loss of sale of fixed assets are reversed as we only want operations.
We if we did this in only only place things would not balance any more.
When we look at the chnage in PPE we also take into account depreciation and indirectly gain/loss on assets as we try to breakdown that chnage in PPE to cash spent on assets or raised from selling assets.
if in CFO we just ha chnage in retained earings and in CFI just chnage in PPE it would help us explain what is going on. But kjusyt like all things to do with accounts we have got to make things balance.
You may fnd interesting - aftter the exam - to look at the cash flow statements produced by credit rating agencies as they often show the same numbers from a different persective, as they are aiming to show what resources are available for paying interest and paying down debt.
Vietnamesboy:
The main 2 financial statements are:
Income and Expenses (Profit and Loss)
Balance Sheet.
When you’re thinking about Depreciation, think Income and Expenses, NOT cash flow.
a very simple example for you.
Suppose I own a firm with no liabilities and exactly one asset, a machine worth \$100.
The Balance sheet will be
Assets (the machine) \$100.
Shareholders’ Equity \$100.
Now suppose the machine breaks and has to be junked…
The firm now has zero assets, \$0.
The firm incurs a loss of \$100 because the machine is worthless and has to be written off.
What do you think the Shareholders’ Equity is now?
The answer is that it is zero.
Income and Expenses:
Write-off of asset \$100
Total Loss \$100
The loss is subtracted from Shareholders’ Equity which becomes \$0
The only difference with depreciation is that instead of writing the asset off in one go, it is written off in installments.
Returning to the firm with one asset (the machine) and no liabilities.
Suppose now we write the value of the machine off in 10 installments, 10\% at the end of each of the first 10 years. And suppose the firm has no sales, no income, and no expenses other than depreciation.
At the end of year 1, the machine will be worth \$90, having been depreciated by 10\%.
At the end of year 1, the only asset is the machine, and there are no liabilities, so shareholders’ equity is now \$90.
Income and Expenses for year 1:
Write-down of asset \$10
Total Loss \$10
The loss is subtracted from Shareholders’ Equity which becomes \$90
The Balance sheet will be
Assets (the machine) \$90.
Shareholders’ Equity \$90.
Here’s how depreciation rebalances the balance sheet:
Income Statement Impact: Depreciation expense is recorded on the income statement as an operating expense. This reduces the net income of the company, which in turn reduces the retained earnings under the equity section of the balance sheet. So, the reduction in net income balances the decrease in the value of assets on the balance sheet.
Accumulated Depreciation: On the balance sheet, the value of the asset decreases due to depreciation, but this decrease is reflected in the accumulated depreciation account. Accumulated depreciation is a contra-asset account, which means it is subtracted from the original cost of the asset. As a result, the net value of the asset (original cost minus accumulated depreciation) decreases, which helps to balance the balance sheet.
By recognizing depreciation expense on the income statement and accumulating it in the contra-asset account (accumulated depreciation) on the balance sheet, the accounting process ensures that the cost of the asset is appropriately allocated over its useful life. This process helps to accurately reflect the true value of assets and the financial performance of the company over time.
