What Is Accelerated Depreciation?
Accelerated depreciation is any method of depreciation used for accounting or income tax purposes that allows greater deductions in the earlier 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 the deduction of higher expenses in the first years after purchase and lower expenses as the depreciated item ages.
Understanding Accelerated Depreciation
The use of accelerated depreciation methods are mostly logistical. Although an asset is not required to be depreciated in the same manner in which it is used, an accelerated depreciation method tends to make this occur. This is because an asset is most heavily used when it is new, functional, and most efficient. Because this tends to occur at the beginning of the asset’s life, the rationale behind an accelerated method of depreciation is that it appropriately matches how the underlying asset is used. As an asset ages, it is not used as heavily, since it is slowly phased out for newer assets.
Utilization of an accelerated depreciation method has financial reporting implications. Because depreciation is accelerated, expenses are higher in earlier periods compared to in later periods. Companies may utilize this strategy for taxation purposes, as an accelerated depreciation method will result in a deferment of tax liabilities due to income being lower in earlier periods. Alternatively, public companies tend to shy away from accelerated depreciation methods, as net income is reduced in the short-term.
Accelerated Depreciation Methods
The double declining balance (DDB) method is an accelerated depreciation method. After taking the reciprocal of the useful life of the asset and doubling it, this rate is applied to the depreciable base, book value, for the remainder of the asset’s expected life. 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 asset's current book value for depreciation. Although the rate remains constant, the dollar value will decrease over time because the rate is multiplied by a smaller depreciable base each period.
The sum-of-the-year’s-digits (SYD) method also allows for accelerated depreciation. To start, combine all the digits of the expected life of the asset. For example, an asset with a five-year life would have a base of the sum of the digits one through five, or 1+ 2 + 3 + 4 + 5 = 15. In the first depreciation year, 5/15 of the depreciable base would be depreciated. In the second year, only 4/15 of the depreciable base would be depreciated. This continues until year five depreciates the remaining 1/15 of the base.