Depreciation is the reduction in value of a long term (fixed) asset due to wear and tear. The depreciation expense can be calculated using a number of methods including straight line, declining balance, and units of production. Each of these methods will provide a different depreciation estimate for each year of the life of the asset. If the calculation results in a higher depreciation expense in the early years compared to the later years, then the depreciation of the asset is said to be accelerated and the calculation is referred to as an accelerated depreciation method.
Use of Accelerated Depreciation Method
The accelerated method is used for the following main reasons:
- Some assets reduce in value due to wear and tear much quicker in the early years, therefore the use of an accelerated method properly reflects the actual wear and tear on an asset over its useful life.
- The additional expense reduces income and therefore tax in the early years thereby deferring tax liabilities (assuming the tax regime allows it). The downside of this of course is that the business appears less profitable in the early years.
Which Depreciation Method is Considered an Accelerated Method?
Not all depreciation calculation methods result in an accelerated depreciation expense. For example, the straight line method calculates a depreciation expense which is the same each year.
The following methods do produce a depreciation expense which is higher in the earlier years than in the later years, and are therefore considered to be accelerated depreciation methods.
- Declining balance depreciation method
- Double declining balance depreciation method
- Sum of Digits depreciation method
Accelerated Depreciation Method Example
If a business purchases an asset costing 20,000 with an estimated salvage value of 1,000 after a 4 year useful life, then the accelerated depreciation for the first 4 years using the double declining balance depreciation is calculated as follows:
Double declining rate = 2 x 1 / Useful life Double declining rate = 2 x 1 /4 = 50% Accelerated depreciation year 1 = 50% x 20,000 = 10,000 Accelerated depreciation year 2 = 50% x 10,000 = 5,000 Accelerated depreciation year 3 = 50% x 5,000 = 2,500 Accelerated depreciation year 4 = 1,500 (to reduce to salvage value)
The depreciation is higher in year 1 (10,000) and declines over the following years and therefore the double declining balance method is referred to as accelerated depreciation method.
Contrast this to the calculation carried out using the straight line method.
Straight depreciation = (Cost - Salvage value) / Useful life Straight depreciation = (20,000 - 1,000) / 4 = 4,750 Straight depreciation year 1 = 4,750 Straight depreciation year 2 = 4,750 Straight depreciation year 3 = 4,750 Straight depreciation year 4 = 4,750
Each year the depreciation expense is the same, the depreciation expense is not accelerated, and the straight line method is not an accelerated depreciation method.
The diagram below compares how the total depreciation is allocated to each of the 4 years for the accelerated method and the straight-line method.
Notice that in both cases over the 4 years, the total depreciation is 19,000 which reduces the asset to its salvage value of 1,000. The accelerated depreciation method simple accelerates the depreciation towards the earlier years, it does not change the total depreciation charge.
When is the Method Used?
The accelerated method is often used when as asset is likely to generate more income in its early years, so that the expenses of using the asset are matched to the income generated by it. In addition, it is also used when the asset is likely to be disposed of before the end of its useful life, such as motor vehicles or computers.
The benefit of using accelerated depreciation formula is that it allows a business to write off its assets quicker, and assuming the tax regime allows it, the accelerated tax depreciation will create a higher depreciation expense in the early years, reduce taxable profits, and therefore the tax expense for the business.
Using an accelerated depreciation method will make the business seem less profitable in its early years and more profitable in the later years.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.