Which of the following statements is true regarding depreciation and amortization?

Which of the following statements is true regarding depreciation and amortization?

• A. They are both cash expenses that must be paid regularly
• B. These expenses are never applicable to intangible assets
• C. They are non-cash expenses
• D. They directly increase cash flows

Answer: (C)

Depreciation and amortization are recognized as non-cash expenses because they represent the allocation of the cost of tangible and intangible assets over their useful lives, rather than actual cash outflows. This accounting treatment allows businesses to account for the wear and tear on physical assets or the declining value of intangible assets without involving actual cash transactions at the time they are recognized. When a company records depreciation, for example, it reduces net income on the income statement but does not involve any cash leaving the business at that time. Similarly, amortization spreads out the cost of intangible assets like patents or copyrights over their useful life, impacting accounting profits without affecting cash flow immediately. Understanding this concept is critical for financial analysis since, while these expenses affect net income, they do not directly impact cash on hand. Such distinction helps analysts better assess the actual cash flow available to a company, as the cash flow statement will add back these non-cash expenses to net income to arrive at cash flows from operations.

Depreciation and amortization are recognized as non-cash expenses because they represent the allocation of the cost of tangible and intangible assets over their useful lives, rather than actual cash outflows. This accounting treatment allows businesses to account for the wear and tear on physical assets or the declining value of intangible assets without involving actual cash transactions at the time they are recognized.

When a company records depreciation, for example, it reduces net income on the income statement but does not involve any cash leaving the business at that time. Similarly, amortization spreads out the cost of intangible assets like patents or copyrights over their useful life, impacting accounting profits without affecting cash flow immediately.

Understanding this concept is critical for financial analysis since, while these expenses affect net income, they do not directly impact cash on hand. Such distinction helps analysts better assess the actual cash flow available to a company, as the cash flow statement will add back these non-cash expenses to net income to arrive at cash flows from operations.