Accelerated depreciation: How is it calculated?

Definition

Accelerated depreciation is a method used in accounting to allocate the cost of a tangible asset over its useful life in a way that allows for larger deductions in the earlier years of the asset’s life compared to the straight-line method of depreciation.

What is accelerated depreciation?

The primary purpose of accelerated depreciation is to match the expenses associated with the use of an asset with the revenue it generates over its useful life more accurately. By front-loading depreciation deductions, businesses can reduce their taxable income and tax liabilities in the earlier years of an asset’s life, providing cash flow benefits and improving financial performance.

There are different methods of accelerated depreciation, including:

Double-declining balance (DDB): Under this method, depreciation expense is calculated by applying a fixed rate to the asset’s book value at the beginning of each period. The depreciation expense decreases over time as the asset’s book value declines.
Sum-of-the-years’-digits (SYD): This method assigns a decreasing fraction to each year of the asset’s useful life, with the total of the fractions equal to the sum of the digits of the asset’s useful life.

Businesses often use accelerated depreciation for assets that are expected to generate higher returns or become outdated more quickly, such as technology or equipment. However, businesses should consider the impact of accelerated depreciation on financial statements, tax liabilities, and cash flow before selecting a depreciation method.

How does accelerated depreciation affect reporting?

Accelerated depreciation impacts financial reporting by accelerating the recognition of depreciation expenses early in an asset’s life compared to straight-line depreciation.

This method results in higher depreciation expenses in the earlier years of asset use and lower expenses in later years. Consequently, accelerated depreciation can reduce taxable income more quickly, which affects reported earnings and income taxes. It also influences the carrying value of assets on the balance sheet, potentially affecting financial ratios and overall financial performance analysis.

Example of accelerated depreciation

Let’s say a company purchases a piece of machinery for £100,000 with an estimated useful life of 5 years and no salvage value. The company decides to use the double-declining balance method, which accelerates depreciation.

Year 1:

Beginning book value: £100,000
Depreciation rate: 40%
Depreciation expense: £40,000 (40% of £100,000)
Ending book value: £60,000 (£100,000 – £40,000)

Year 2:

Beginning book value: £60,000
Depreciation rate: 40%
Depreciation expense: £24,000 (40% of £60,000)
Ending book value: £36,000 (£60,000 – £24,000)

And so on for subsequent years, until the asset’s book value reaches its salvage value of £0.

Using the double-declining balance method, the company can front-load the depreciation expense, recognising higher expenses in the earlier years of the asset’s life.