What is the 'Retirement Method of Depreciation '

Retirement method of depreciation describes the accounting practice of delaying the depreciation of a fixed asset until it is retired from service. This is in contrast to allocating its costs across the useful life of the asset. At retirement, the depreciation expense is debited and then the asset account for the retired asset is credited. The depreciation expense must be reduced by the asset's salvage value, if any. Public utilities and railroads are the main types of businesses that might use this type of depreciation, though the use of the retirement method of depreciation has fallen into disuse for the most part.

Breaking Down 'Retirement Method of Depreciation '

The retirement method of depreciation, as well as the replacement method of depreciation, are meant to help simplify and reduce the burden of accounting and recordkeeping for companies that own many similar assets that individually are low in value but together represent a significant expense. An electric company might use the retirement method of depreciation to account for the electric meters that are installed on the sides of residents' homes, for example. A railroad may use such methods to avoid detailed and time-consuming depreciation schedule for individual assets, such as ties, conductors, switches, telephones, poles and more. The common theme is the ownership of a large number of smaller items that represent relatively small sums when taken individually.

Retirement Method of Depreciation vs. Replacement Method

How the retirement method of depreciation and the replacement method of depreciation differ is retirement method charges the cost of the retired asset (minus salvage value) to depreciation expense. Meanwhile the replacement method charges the cost of the asset purchased (minus salvage value from the asset retired) to depreciation expense. This means that the retirement method follows a FIFO (first in, first out) flow because the first asset to be expensed will be the first asset purchased. By contrast, the replacement method follows a LIFO (last in, first out) flow because the first asset expensed was the last asset purchased.

Retirement Method of Depreciation Issues

The retirement method of depreciation has a number of issues. They include:

  • The fixed assets of a company are frequently overstated because they are not seeing a reduction via an ongoing depreciation charge.
  • Since expenses are deferred, reported income may not be accurate (depreciation expense is understated while net income is overstated).
  • Since the expenses of a business are being deferred, any financial performance data for it is likely to be inaccurate (biased toward the positive side).
  • An accurate allocation of costs to all periods does not occur, especially in the early years.
RELATED TERMS
  1. Accelerated Depreciation

    Any method of depreciation used for accounting or income tax ...
  2. Annuity Method of Depreciation

    The annuity method of depreciation is a method used to calculate ...
  3. Depreciated Cost

    Depreciated cost is the original cost of a fixed asset less accumulated ...
  4. Salvage Value

    The estimated value that an asset will realize upon its sale ...
  5. Sum-Of-The-Years' Digits

    An accelerated method for calculating an asset's depreciation. ...
  6. Depreciation

    1. A method of allocating the cost of a tangible asset over its ...
Related Articles
  1. Financial Advisor

    How Does Depreciation Reduce My Tax Bill?

    How the depreciation tax rule can assist real estate investors.
  2. Investing

    How Depreciation Works on a Rental Property

    One of the advantages of owning rental real estate is the depreciation tax deduction.
  3. Retirement

    7 Steps to Create a 10-Years-from-Retirement Plan

    Workers who are only 10 years away from retiring need to do a number of things to ensure that a comfortable retirement can be achieved.
  4. Investing

    EBITDA

    Otherwise known as Earnings Before Interest, Taxes, Depreciation and Amortization. Learn more about this indicator of a company's financial performance.
  5. Retirement

    10 Things You Must Know Before You Retire

    Don't put off your retirement planning - these 10 steps can make your later years much more manageable.
  6. Retirement

    Retirement Income Planning Made Easier With the 3-7-5 Strategy

    If you are worried about running out of retirement income, use the 3-7-5 strategy.
  7. Retirement

    Top Retirement Prep Questions to Ask Clients

    Is your client really ready for retirement? Here are some essential questions to ask.
  8. Managing Wealth

    Cars That Depreciate In Value The Most

    You can't avoid depreciation on your car, but you can avoid certain models that depreciate in value a lot.
  9. Retirement

    Retiring Soon? 10 Things to Consider First

    Consider these 10 questions and to-dos before you retire to make sure you are ready.
RELATED FAQS
  1. What is the relationship between accumulated depreciation and depreciation expense?

    Understand the relationship between accumulated depreciation and depreciation expense. Learn how each one is accounted for ... Read Answer >>
  2. How does accumulated depreciation affect net income?

    Learn why accumulated depreciation does not directly affect a company's net income; understand where a company accounts for ... Read Answer >>
  3. When should I use depreciation expense instead of accumulated depreciation?

    Distinguish differences between depreciation expense, which is reported on the income statement, and accumulated depreciation ... Read Answer >>
  4. Are noncurrent assets depreciated?

    Learn about depreciation, why noncurrent assets are depreciated and how to calculate depreciation expenses using a straight-line ... Read Answer >>
  5. Why does accumulated depreciation have a credit balance on the balance sheet?

    Wonder why accumulated depreciation is a credit account, despite residing on the asset side of the balance sheet? Why not ... Read Answer >>
  6. How does proration affect asset depreciation?

    Learn how different proration or applicable convention methods such as half-year, mid-quarter and mid-month affect asset ... Read Answer >>
Hot Definitions
  1. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  2. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  3. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
  4. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
  5. Return on Investment (ROI)

    Return on Investment (ROI) is a performance measure used to evaluate the efficiency of an investment or compare the efficiency ...
  6. Interest Coverage Ratio

    The interest coverage ratio is a debt ratio and profitability ratio used to determine how easily a company can pay interest ...
Trading Center