Tennessee Business and Law Practice Exam 2025 – Complete Test Prep Guide

Depreciation is a significant financial concept that is categorized under operating expenses on the income statement. It represents the allocation of the cost of tangible assets, like machinery or vehicles, over their useful lives. By accounting for depreciation, a business recognizes the gradual wear and tear on its assets, which directly impacts its operating expenses.

When depreciation is recorded, it reduces the taxable income of the business since it is considered an expense. This, in turn, affects the net profit as it lowers the net income reported at the bottom of the income statement. However, while depreciation does influence net profit, its primary classification is within the operating expenses section.

Understanding the nature of depreciation is essential for accurately portraying the financial health of a business, as it provides stakeholders insight into how businesses invest in and manage their long-term assets. This accounting practice ensures that the expense is matched with the revenue generated in the same period, in accordance with the matching principle in accounting, which enhances the accuracy of financial reporting.