Depreciation is the reduction in value of a long term (fixed) asset due to wear and tear. The depreciation expense can be calculated using a number of methods including straight line, declining balance, and units of production. Each of these methods will provide a different depreciation estimate for each year of the life of the asset.
If the calculation results in a higher depreciation expense in the early years compared to the later years, then the depreciation of the asset is said to be accelerated and the calculation is referred to as an accelerated depreciation method.
Use of Accelerated Depreciation Method
The accelerated depreciation method is used for the following main reasons:
- Some assets reduce in value due to wear and tear much quicker in the early years, therefore the use of an accelerated depreciation method properly reflects the actual wear and tear on an asset over its useful life.
- The additional expense reduces income and therefore tax in the early years thereby deferring tax liabilities (assuming the tax regime allows it). The downside of this of course is that the business appears less profitable in the early years.
Which Depreciation Method is Considered an Accelerated Method?
Not all depreciation calculation methods result in an accelerated depreciation expense. For example, the straight line method calculates a depreciation expense which is the same each year.
The following methods do produce a depreciation expense which is higher in the earlier years than in the later years, and are therefore considered to be accelerated depreciation methods.
- Declining balance depreciation method
- Double declining balance depreciation method
- Sum of Digits depreciation method
Accelerated Depreciation Method Example
If a business purchases an asset costing 9,000 with an estimated salvage value of 1,000 after a 4 year useful life, then the accelerated depreciation for the first 4 years using the double declining balance depreciation is calculated as follows:
Double declining rate = 2 x 1 / Useful life Double declining rate = 2 x 1 /4 = 50% Accelerated depreciation year 1 = 50% x 9,000 = 4,500 Accelerated depreciation year 2 = 50% x 4,500 = 2,250 Accelerated depreciation year 3 = 50% x 2,250 = 1,125 Accelerated depreciation year 4 = 125 (to reduce to salvage value)
The depreciation is higher in year 1 (4,500) and declines over the following years and therefore the double declining balance method is referred to as accelerated depreciation method.
Contrast this to the calculation carried out using the straight line method.
Straight depreciation = (Cost - Salvage value) / Useful life Straight depreciation = (9,000 - 1,000) / 4 = 2,000 Straight depreciation year 1 = 2,000 Straight depreciation year 2 = 2,000 Straight depreciation year 3 = 2,000 Straight depreciation year 4 = 2,000
Each year the depreciation expense is the same, the depreciation expense is not accelerated, and the straight line method is not an accelerated depreciation method.
Notice that in both cases over the 4 years, the total depreciation is 8,000 which reduces the asset to its salvage value of 1,000. The accelerated depreciation method simple accelerates the depreciation towards the earlier years, it does not change the total depreciation charge.
When is Accelerated Depreciation Method Used?
The accelerated depreciation method is often used when as asset is likely to generate more income in its early years, so that the expenses of using the asset are matched to the income generated by it. In addition, it is also used when the asset is likely to be disposed of before the end of its useful life, such as motor vehicles or computers.