If Depreciation Increases by $10: Three Statements Interview Walkthrough

"Depreciation increases by $10. Walk me through the three statements." is still one of the highest-frequency IB technicals. They want linkages, tax effects, and calm sequencing. Messy order loses points even if the ending cash is right.

The short answer

"Assuming a 20% tax rate, depreciation up $10 lowers pre-tax income by 10, taxes by 2, and net income by 8. On the cash flow statement, net income is down 8 but I add back the 10 of depreciation, so cash is up 2. On the balance sheet, cash up 2, PP&E down 10, and equity down 8 from net income. The balance sheet balances."

Assumptions to lock first

State them out loud:

• Tax rate (use 20% or 40% if they do not specify; this guide uses 20%)
• Depreciation is the only change
• No change to CapEx cash spend in this instant (pure P&L depreciation increase)

The walkthrough (20% tax)

NI −8
CFO = −8 + 10 = +2
Cash +2; PP&E −10; Equity −8

Sequencing tip

Always walk Income Statement → Cash Flow Statement → Balance Sheet. If you jump to cash first, you often forget the tax line or the equity plug. If they interrupt with "what about CapEx," finish the pure depreciation case in one breath, then layer the investing outflow. Interviewers are testing composure under a twist as much as the arithmetic.

Also watch units: if they say depreciation expense rises by $10, that is the pre-tax P&L hit. Do not silently switch to an after-tax $8 when you do the addback. Add back $10 on CFO every time.

Why cash goes up

You get a tax shield. Depreciation reduced taxable income, so you paid less tax. The non-cash charge is added back on the cash flow statement. Net effect at a 20% tax rate: +$2 cash.

At a 40% tax rate: NI −6; CFO −6 + 10 = +$4 cash.

The intuition to lock: cash moves by tax rate × depreciation increase, not by the full expense. The expense is non-cash; the tax savings is cash.

Balance sheet balance check

No plug needed. If your assets and equity do not move together, you missed the tax or the addback.

Common variants

Depreciation increases $10 and CapEx increases $10 (cash CapEx)

Now you also spend $10 cash on CapEx (investing outflow). Roughly:

• P&L / CFO tax effects from depreciation still apply as above
• Investing: −10 CapEx
• Net cash effect ≈ +2 from ops − 10 CapEx = −8 (at 20%), and PP&E: −10 dep +10 CapEx = flat before other items

Clarify timing: same period purchase vs depreciation on existing assets only.

"What if tax rate is zero?"

NI −10; add back +10; cash unchanged; PP&E −10; equity −10. Still balances.

EBITDA impact

EBITDA is before D&A, so EBITDA unchanged. EBIT down $10. That distinction is a frequent follow-up. See EBITDA vs EBIT.

How to say it in 45 seconds

"Assuming a 20% tax rate, depreciation up $10 lowers pre-tax income by 10, taxes by 2, and net income by 8. On the cash flow statement, net income is down 8 but I add back the 10 of depreciation, so cash is up 2. On the balance sheet, cash up 2, PP&E down 10, and equity down 8 from net income. The balance sheet balances."

Stop. Wait for the CapEx or tax-rate twist.

Mistakes that fail

1. Forgetting the tax shield
2. Adding back only the after-tax depreciation
3. Reducing cash by $10 because "depreciation is a cost"
4. Walking statements out of order and losing the plot
5. Changing EBITDA when asked carefully about EBITDA

Practice set (do all four aloud)

1. Dep +$10, tax 20%
2. Dep +$10, tax 40%
3. Dep +$10, tax 0%
4. Dep +$10 and cash CapEx +$10, tax 20%

Then extend to related drills: accrued expense increases, inventory increases, and working capital questions. Practice on Project Catalyst until the IS → CFS → BS order is automatic.

Related

For a wider depreciation discussion see Depreciation and the Three Statements. This page is the interview drill form. For inventory and AP cousins, keep those three-statement drills in the same practice block so linkages stay sharp.