When an asset is new and at its most efficient, a company uses it the most. This is the guiding principle behind the accelerated depreciation method used in accounting for tax purposes. Here’s a closer look at how accelerated depreciation is calculated and when it might be beneficial.
Accelerated depreciation definition
Accelerated depreciation is a method used to calculate asset value over time. It’s based on the principle that an asset’s value is highest at the beginning of its lifespan, allowing for more significant depreciation in value during these first few years. Several different methods are used to work out the accelerated depreciation calculation. The two main options include:
Sum of the Years’ Digits (SYD)
Double Declining Balance Method
We’ll explore these in greater detail below.
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.
Accelerated depreciation methods
To calculate accelerated depreciation, you can use a few different methods. Here’s a little more information about the Sum of the Years’ Digits method and the Double Declining Balance method:
Sum of the years’ digits (SYD)
The formula used in SYD calculations is as follows:
Sum of the Years’ Digits Depreciation = Depreciable Cost x (Remaining Useful Life / Sum of Years’ Digits)
You can calculate the Sum of the Years’ Digits like so:
Sum of the Years’ Digits = (Useful Life x (Useful Life + 1)) / 2
Double declining balance method
With the double declining balance method, the formula is as follows:
Double Declining Depreciation = 2 x Straight-Line Depreciation Rate x Value at Beginning of the Year
As you can see, for the double declining balance method to work, you’ll need to know how to calculate the straight-line depreciation rate. You can use the following formula to do so:
Straight-Line Depreciation = (Purchase Price – Salvage Value) / Useful Life
Are there accelerated depreciation tax benefits?
In the short term, there can be income tax benefits to using this method. While the straight-line method calculates depreciation evenly over time, businesses can deduct higher expenses during the first few years of an asset’s lifespan using the accelerated depreciation method. The expenses are then lowered as the asset is used less later in its lifespan.
For example, according to US income tax regulations, a business must use straight-line depreciation on financial statements but is able to use accelerated depreciation on income tax returns. This means that the company could deduct higher expenses on the income tax return.
At the same time, the depreciation of your company’s assets has an impact on profits. During the earlier years of an asset’s lifespan, the company would report a lower profit due to the financial loss associated with its acquisition. Then, in later years, the asset is likely to show a lower rate of depreciation, with a higher reported profit. As a result, it’s a potentially useful accounting concept for any business owner to be aware of.
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