What are the effects on the accounting equation from the adjustment for depreciation?

• A. Assets decrease and equity decreases
• B. Liabilities decrease and equity increases
• C. Liabilities increase and assets decrease
• D. Assets increase and equity increases

Answer: (A)

Verified step by step guidance

1. Understand the concept of depreciation: Depreciation is the allocation of the cost of a tangible asset over its useful life. It represents the reduction in the value of an asset due to wear and tear, obsolescence, or usage.
2. Identify the impact of depreciation on the accounting equation: The accounting equation is Assets = Liabilities + Equity. Depreciation reduces the value of assets, specifically fixed assets, and also reduces equity because it is recorded as an expense, which decreases retained earnings.
3. Recognize how depreciation is recorded: Depreciation is recorded as a debit to Depreciation Expense (an equity account) and a credit to Accumulated Depreciation (a contra-asset account). This reduces the net book value of the asset and equity simultaneously.
4. Analyze the options provided: Based on the accounting equation, the correct effect of depreciation is that assets decrease (due to accumulated depreciation) and equity decreases (due to the expense reducing retained earnings). Liabilities are not affected by depreciation.
5. Conclude the correct answer: The correct answer is 'Assets decrease and equity decreases,' as depreciation impacts both the asset and equity sides of the accounting equation.