What is Accelerated Depreciation?
Accelerated depreciation is referred to those methods where the asset cost is depreciated at a faster rate than the straight-line method, and therefore it leads to larger depreciation expenses in the earlier years than the later period of asset’s useful life. The main purpose of using this method is the belief that assets are more productive in the early years than later years. Declining Balance Method and Sum of Years Digit Method are the two such popular methods.
Understanding Accelerated Depreciation
Accelerated depreciation methods tend to align the recognized rate of an asset’s depreciation with its actual use, although this isn’t technically required. This alignment tends to occur because an asset is most heavily used when it’s 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 age, it is not used as heavily, since it is slowly phased out for newer assets.
How does Accelerated Depreciation Work?
Depreciation of any kind is a reduction in the value of an asset that is placed in service for business purposes. The wear, tear, and usage of that asset will lower its value over time, and for accounting purposes, this is an expense to the business owner.
If you calculate the reduction in the value of an asset by dividing its value by its useful life (in years), this is called straight-line depreciation. This method assumes that the asset will lose value evenly over its lifespan.
For example, with straight-line depreciation, if you pay $20,000 for a truck and you expect it to have value for 10 years, your depreciation expense is $2,000 per year.
Accelerated depreciation assumes that the value of an asset will lower more quickly in the first few years in service (due to high use). It was also created as a way for business owners to lower taxable income while investing in a business by purchasing assets.
Popular Accelerated Depreciation Methods
The most popular accelerated depreciation methods are the double declining balance method and the sum of the years’ digits method. The formula for calculating depreciation using each of these methods is given below:
1. Double declining balance method:
Double declining balance = 2 x Straight-line depreciation rate x Book value at the beginning of the year
2. Sum of the years’ digits method:
Applicable percentage (%) = Number of years of estimated life remaining at the beginning of the year / SYD
SYD = n(n+1) / 2
- SYD stands for sum of the years’ digit
- n = number of years
Accelerated depreciation vs. straight-line depreciation
An asset’s value follows a steady trajectory over time in a straight-line depreciation method. With accelerated depreciation, the asset depreciates in cost more during the early years of its lifespan, with a slower depreciation rate later. No matter the method of depreciation, all assets should end up with the same final amount of depreciation. The main difference between accelerated depreciation vs. straight-line depreciation is timing.
Benefits of using Accelerated Depreciation
Accelerated depreciation can help a business lower its taxable income in the early stages of growth, when income may be lower and asset expenses may be higher. Using an accelerated method of depreciation also offsets some of the costs of business growth and expansion, encouraging business owners to reinvest into the business.
Accelerated depreciation is also a more realistic way to track the value of an asset. A new asset will lose value quicker than a used asset, and therefore accelerated depreciation of that asset is more congruent with its real valuation.
When to use Accelerated Depreciation
Accelerated depreciation is best used by start-up businesses that need to purchase a large amount of business equipment, but want to offset the cost of that equipment with tax savings. It is also a good idea for businesses that have large equipment expenses to keep up with business growth and expansion. The tax savings can help a business deploy more of its capital on equipment and assets, accelerating business growth.