Final answer:
The correct answer is option 3. If depreciation is not recorded, net income would be overstated and expenses would be understated since the cost of assets would not be expensed over their useful life, leading to inflated profits.
Step-by-step explanation:
If depreciation is not recorded on the financial statements, then option 3 would occur: Net income would be overstated, and expenses would be understated. This is because depreciation is an expense that accounts for the decrease in value of an asset over time. Without recording this expense, the cost of assets is not being matched with the revenue they help to generate, misleadingly inflating net income and not accurately tracking the expensing of the asset's cost over its useful life.
Assets would appear higher than their true economic value because their cost has not been reduced through yearly depreciation entries. Consequently, the expense side on the income statement would be missing the depreciation expense. This results in a higher net income than what should be reported because expenses are reduced, and thus, profits appear higher.