Accelerated Depreciation

Accelerated depreciation refers to any one of several methods by which a company, for 'financial accounting' or tax purposes, depreciates a fixed asset in such a way that the amount of depreciation taken each year is higher during the earlier years of an asset’s life. For financial accounting purposes, accelerated depreciation is expected to be much more productive during its early years, so that depreciation expense will more accurately represent how much of an asset’s usefulness is being used up each year. For tax purposes, accelerated depreciation provides a way of deferring corporate income taxes by reducing taxable income in current years, in exchange for increased taxable income in future years. This is a valuable tax incentive that encourages businesses to purchase new assets.

Three examples of accelerated depreciation methods include:

• double-declining (200% declining) balance,
• 150% declining balance, and
• sum-of-the-years' digits (SYD).

If a company elects not to use accelerated depreciation, it can instead use the straight-line method, where it depreciates an asset at the same standard rate throughout its useful life.

When Accelerated Depreciation is Not Used

Accelerated depreciation requires additional depreciation calculations and record keeping, so some companies avoid it for that reason (though fixed asset software can readily overcome this issue). Companies may also ignore it if they are not consistently earning taxable income, which takes away the primary reason for using it. Companies may also ignore accelerated depreciation if they have a relatively small amount of fixed assets, since the tax effect of using accelerated depreciation is minimal. Finally, if a company is publicly held, management may be more interested in reporting the highest possible amount of net income in order to buoy its stock price for the benefit of investors - these companies will likely not be interested in accelerated depreciation, which reduces the reported amount of net income.

Financial Analysis Effects

From a financial analysis perspective, accelerated depreciation tends to skew the reported results of a business to reveal profits that are lower than would normally be the case. This is not the situation over the long-term, as long as a business continues to acquire and dispose of assets at a steady rate. To properly review a business that uses accelerated depreciation, it is better to review its cash flows, as revealed on it statement of cash flows.