Accounting for Planning and Control Test 1 Practice 2026 - Free Practice Questions and Study Guide

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Which of the following statements is true about depreciation?

Depreciation has no effect on taxes.

Depreciation increases taxes payable.

Depreciation reduces net income with no impact on cash flows.

Depreciation affects taxes and has an indirect effect on cash flows via taxes.

Depreciation is a non-cash expense that lowers reported income. Because it reduces taxable income, it lowers taxes payable, creating a tax shield. Since it’s non-cash, it doesn’t use cash when recorded, but the reduced taxes flow through to cash flows, making an indirect improvement in cash flow. That combination—affecting taxes and, via the tax saving, influencing cash flows—fits reality best. Depreciation does not have no effect on taxes, nor does it increase taxes payable, and it does impact cash flows through the tax shield, not just leave cash flows untouched.