What is accelerated depreciation?
Accelerated depreciation is any depreciation method used for accounting or tax purposes that allows for greater deductions during the first years of the life of an asset. While the straight-line depreciation method spreads the cost evenly over the life of an asset, an accelerated depreciation method allows you to deduct higher expenses in the first years after purchase and lower expenses at as the amortized element ages.
Understanding accelerated depreciation
The accelerated depreciation methods are mainly logistical. Although an asset should not be depreciated in the same way as it is used, an accelerated depreciation method tends to do so. In fact, an active ingredient is used the most when it is new, functional and most effective. Since this tends to happen at the start of the asset’s lifespan, the rationale for an accelerated depreciation method is that it appropriately matches the way the underlying asset is used. As an asset ages, it is not used as intensively as it is phased out for new assets.
The use of an accelerated amortization method has implications for financial reporting. As depreciation is accelerated, expenses are higher in previous periods compared to later periods. Businesses can use this strategy for tax purposes, as an accelerated depreciation method will result in the deferral of tax liabilities due to declining revenues in previous periods. Alternatively, SOEs tend to avoid accelerated depreciation methods because net income is reduced in the short term.
Accelerated depreciation methods
The declining balance double method (DDB) is an accelerated depreciation method. After taking the inverse of the useful life of the asset and doubling it, this rate is applied to the depreciable base, the book value, for the remainder of the expected life of the asset. For example, an asset with a useful life of five years would have a reciprocal value of 1/5 or 20%. Double the rate, or 40%, is applied to the current carrying amount of the asset for depreciation. Although the rate remains constant, the dollar value will decrease over time because the rate is multiplied by a smaller depreciable base in each period.
The sum of the year figures (SYD) method also allows accelerated depreciation. To get started, combine all the numbers for the asset’s expected life. For example, an asset with a useful life of five years would have a base of the sum of the digits from one to five, or 1+ 2 + 3 + 4 + 5 = 15. In the first year of depreciation, 5 / 15 of the basic depreciation would be depreciated. In the second year, only 4/15 of the depreciable base would be depreciated. This continues until the fifth year depreciates the remaining 1/15 of the base.