What effect does understating the rate of depreciation have on company profits and book value?

Understating the rate of depreciation leads to a situation where the expense related to the wear and tear on fixed assets is reported at a lower level than it actually should be. This means that less of the asset's cost is reflected as an expense in the income statement, which results in higher net income being reported.

When depreciation is understated, the company's profits appear to be inflated because the expense that reduces profits is not accurately accounting for the asset's usage and decline in value. This creates a misleading impression of financial health, as the company’s income statement shows higher profits than it should, given the actual cost of using those assets.

Additionally, the book value of the assets on the balance sheet will also be overstated because the accumulated depreciation will be less than what it should be, leading to an inflated asset value. This discrepancy can mislead investors and stakeholders regarding the true financial position of the company.

The other choices do not accurately reflect the effects of understating depreciation. They either suggest that there is no impact on profits or imply that expenses are increasing and income is decreasing, which is contrary to the reality of understating depreciation.