Accelerated depreciation is any type of depreciation used for accounting or income tax reasons that permit larger depreciation charges in the first years of an asset's life. Accelerated depreciation techniques, such as the double-declining balance (DDB), result in greater initial depreciation costs and reduced ongoing costs as the asset matures. On the other hand, the straight-line depreciation approach uniformly distributes the expense across the asset's useful life.

Understanding Accelerated Depreciation

Accelerated depreciation techniques tend to correlate the recognized rate of an asset's depreciation with the actual usage of the asset, while this is not necessarily necessary. This alignment often occurs because an asset sees the heaviest usage when it is first put into operation, when it is fully functioning, and when it is most efficient.

The reasoning for an accelerated depreciation method is that it adequately fits how the underlying asset is utilized. This often occurs at the beginning of the asset's life. As an asset ages, it is used less often since more recent assets gradually replace it.

Special Considerations

The use of an accelerated method of depreciation may have an impact on a company's financial reporting. Expenses are greater in early periods than later due to accelerated depreciation. This tactic may be used by businesses to reduce their tax burden since the use of an accelerated depreciation technique will postpone tax obligations due to the fact that revenue will be lower in the earlier time periods. However, because accelerated depreciation techniques diminish net profits soon, public corporations tend to refrain from using them.

Types

Double Declining Balance Method

A double-declining balance method is a form of accelerated depreciation. This rate is applied to the depreciable base, also known as the book value, for the duration of the asset's estimated life after taking the reciprocal of the asset's usable life and doubling it.

A five-year-old asset, for instance, would have a reciprocal value of one-fifth, or twenty percent. Depreciation is calculated by applying a rate twice as high, or 40%, to the asset's current book value. Even though the rate does not change, the dollar value will gradually lessen because the rate is multiplied by an ever-shrinking depreciable base each month.

The Sum of the Years' Digits

Accelerated depreciation is also possible using the sum-of-the-years'-digits (SYD) approach. To begin, add up all of the numbers that represent the anticipated lifespan of the asset. For instance, an asset having a five-year lifespan would have a base of the sum of the numbers one through five, or 1 + 2 + 3 + 4 + 5 = 15.

The depreciable base would be reduced by 5/15 in the first year of depreciation. Just 4/15 of the depreciable basis would be written off in the second year. This process will continue until the remaining 1/15 of the base is depreciated in year five.

Financial Statement Impact of Different Depreciation Methods

The amount of depreciation that occurs each year varies depending on the technique that is used, as can be seen in the tables that are above. Compared to the straight-line depreciation technique, the accelerated methods of depreciation result in a higher amount of depreciation in the early years. How does using an accelerated depreciation method impact the value of an asset and a company's net income?

A company's stated earnings are impacted by the amount of depreciation that an asset has undergone (through the income statement). As a result, the accelerated depreciation techniques distort the company's earnings and indicate a smaller profit in the initial years of the asset's purchase. As the asset gets closer to the end of its useful life, the yearly depreciation that it is subject to decreases, which ultimately results in the firm achieving a larger reported profit in the latter years of the asset's useful life.

Tax Savings and Net Present Value

During the first years of an asset's existence, businesses often use quick depreciation techniques to save taxes. It is essential to remember that the total amount of tax deductions that may be claimed throughout an asset's lifetime will remain the same regardless of the chosen method. Just the timing of the deductions is advantageous using an accelerated procedure.

In the early years, rapid procedures result in larger tax savings, whereas in subsequent years, they result in fewer savings. Since company owners and managers consider the Time Value of Money concept, it is in your best interest to accumulate money as soon as possible rather than waiting. It contributes to an increase in the company's Net Present Value.