Oct 08, 2026 by Offer

How does depreciation affect the three statements (Explained): Interview Answer Guide 2027

This depreciation interview question is the classic three-statement test: $10 of depreciation lowers operating profit by $10, reduces taxes so net income falls only about $7 (at a 30% tax rate), gets added back on the cash flow statement so cash actually rises $3, and on the balance sheet PP&E falls $10 while retained earnings falls $7 — everything balances.

What This Depreciation Interview Question Tests

Depreciation is the accounting allocation of a past capital expenditure over an asset's useful life — a non-cash charge that reduces reported profit without spending cash today. Interviewers use it as the standard probe of three-statement fluency because the correct answer requires holding the income statement, cash flow statement, and balance sheet in your head simultaneously.

Trace $10 of depreciation with a 30% tax rate. On the income statement, operating profit falls $10; the tax charge falls $3 (the tax shield — depreciation is tax-deductible); net income falls $7.

How to Answer This Depreciation Interview Question

Announce your tax assumption up front — “assuming a 30% tax rate” — then walk the statements in fixed order. Income statement: EBIT down $10, tax down $3, net income down $7. Cash flow statement: net income down $7, add back $10 of D&A, operating cash flow up $3. Balance sheet: PP&E down $10, cash up $3, retained earnings down $7.

Common Mistakes on the Depreciation Interview Question

Forgetting the tax shield. Saying net income falls the full $10 ignores that depreciation is tax-deductible. The $3 tax saving is the most commonly dropped piece.

Saying cash decreases. Depreciation involves no cash outflow — after the add-back, operating cash flow rises by the tax shield. Claiming cash falls reveals the candidate is reciting, not reasoning.

Breaking the balance sheet. If your PP&E, cash, and retained earnings movements don't net to equal changes on both sides, something is wrong — always run the balance check before finishing.

This is the kind of technical question that commonly decides interview rounds — candidates report that one hesitant or rambling answer here can end the process on the spot. Practice saying your answer out loud until it sounds calm, structured, and confident.

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FAQ

Why is depreciation added back on the cash flow statement?

Because it reduced net income without consuming cash. The indirect cash flow method starts from net income, so every non-cash charge must be reversed to arrive at actual cash generated.

Does depreciation affect valuation?

Indirectly: it lowers taxable income, creating a tax shield that raises free cash flow, which is what a DCF values. The depreciation number itself is added back, so only the tax effect flows through.

What is the difference between depreciation and amortization?

Depreciation applies to tangible assets like machinery; amortization applies to intangible assets like patents. Economically they work the same way — non-cash allocation of past spend over useful life.

Can depreciation ever be a cash outflow?

The charge itself never is — the cash left when the asset was purchased. That is exactly why the original capex appears in investing cash flow in the purchase year, not spread across periods. Interview format may vary by role and region — check the official careers page for the current process.

Preparing for KPMG's interview? Our 2027 KPMG Online Assessment and Video Interview Tutorials has practice questions and answers — $79 one-time, instant download.