The Three Statements: the Depreciation Question and Its Follow-Ups

If banking interviews have one universal question, it is this: 'depreciation goes up by US$10, walk me through the three statements.' I asked it constantly and not because the accounting is hard. I asked it because it reveals, in ninety seconds, whether a candidate can hold three moving pieces in a fixed order under mild pressure, which is a fair miniature of the job itself. Here is the answer that scores and the machinery around it.

The model answer

The answer that scores · depreciation up US$10

First, my assumption: a 25% tax rate.

Income statement: depreciation rises 10, so pre-tax income falls 10, tax falls 2.50 and net income falls 7.50.

Cash flow statement: net income starts 7.50 lower, but depreciation is non-cash, so I add the 10 back; net cash flow rises by 2.50.

Balance sheet: cash is up 2.50 and PP&E is down 10, so assets are down 7.50; retained earnings fall 7.50 through net income, so equity is down 7.50 and the balance sheet balances.

Where the marks actually sit

The stated assumption. Opening with the tax rate, unprompted, is the single strongest signal in the answer. It shows you know the result depends on it and it is what a careful analyst does before any calculation: state the inputs. Any clean rate is fine; announcing it is the point.
The order. Income statement, then cash flow, then balance sheet, every time. Net income feeds both of the others, so the sequence is logical, not conventional and being able to say why the order exists is worth more than the arithmetic.
The closing check. Ending with 'and the balance sheet balances', having shown both sides move by 7.50, closes the loop. Answers that trail off after the cash line leave the examiner to finish the proof and examiners notice who made them do it.
The punchline, if invited. Cash went up because of the tax shield: a non-cash expense reduced a real cash outflow. One sentence and it converts a mechanical walk into a demonstration of understanding.

The follow-ups that come next

The base question is the entry fee; interviewers escalate along predictable lines. Where does depreciation sit on the income statement: inside cost of sales or operating expenses depending on the asset and the walk-through is unchanged either way. What happens next year: depreciation continues against a lower asset base while the cash difference compounds. Then the multi-year version: US$100 of capex, walked through year zero and year one, which tests whether you can run the same machine with two moving parts, investing outflow first, depreciation starting after. And the variations on the theme: inventory bought with cash versus on payables, an accrued expense, a write-down. Every variant is the same skill and the modelling tests article shows where that skill gets examined in Excel rather than aloud.

Why they really ask it

By superday, nobody doubts you can learn accounting. The question is a stress test of precision: can you keep signs, order and a running total straight while someone watches you. Candidates fail it not from ignorance but from rushing, skipping the assumption, or losing the thread halfway and improvising. So the preparation is not more reading; it is repetition aloud, until the walk is boring and then the follow-ups aloud until those are too. The statements are also the substrate for everything upstream: the free cash flow definition inside the DCF anchor article is built from these exact linkages and the whose-cash logic continues into the EV and equity value piece on this site.

Ten clean repetitions with a live listener will do more than a weekend of notes. If you want that listener to be someone who scored the question professionally, the IBD Recruiting Review is one session.

FAQ

How do I answer the depreciation up 10 question?

State a tax rate first, then walk income statement, cash flow, balance sheet in order: net income down 7.50 at 25% tax, cash up 2.50 after the add-back and the balance sheet balances.