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Differences between Accelerated Depreciation and Straight-Line Depreciation
In the context of a company, "depreciation" refers to any form of value loss that occurs during the course of ownership of an asset. The value of the asset decreases as a result of normal wear and tear as well as regular use. It is unavoidable, and the cost will be borne by the owner of the firm.
In this article, we will look at two types of depreciation namely, Accelerated Depreciation and Straight-Line Depreciation. Let's investigate the distinctions between the two, and then talk about how you might use each one in your company.
What is Accelerated Depreciation?
Accelerated depreciation is a process that is used to calculate the worth of an asset over the course of time. It is predicated on the idea that an asset's lifecycle begins when it has the greatest potential for growth in terms of value. As a result, it makes it possible to claim a more significant amount of depreciation during these early years. Accounting professionals utilize it in order to prepare tax returns. It is a method for lowering one's tax burden.
Accelerated Depreciation is most useful for start-up companies that need to buy a substantial amount of machinery but want to reduce their tax liability as much as possible as a result of the expenditure. It is also a smart idea for firms that have significant expenditures on equipment to stay up with the development and expansion of the company.
There are two ways to calculate the accelerated depreciation, which are as follows −
Sum of the Year’s Digit (SYD)
Double Declining Balance Method
Sum of the Year’s Digit
This is how it is calculated −
$$\mathrm{Sum \, of\, the\, Years'\, Digit's\, Depreciation\, =\,Depreciable \, Cost \times \frac{Remaining\, Life}{Sum\, of\, Years'\, Digits} }$$
To calculate the Sum of Years’ Digits,
$$\mathrm{Sum \, of\, the\, Years'\, Digits\, =\,\frac{(Useful\, Life \times (Useful\, Life + 1)}{2}}$$
Double Declining Balance Method
This is how it is calculated −
$$\mathrm{Double\, Declining\, Depreciation\, =\, 2 \times Straight\, Line\, Depreciation\, Rate\, \times Value\, at\, the\, beginning\, of\, the\, year}$$
Advantages of Using Accelerated Depreciation Method
The advantages of using accelerated depreciation method are as follows −
In the beginning phases of a company's expansion, this strategy may help to reduce the amount of income that is subject to taxation. In a normal situation, the revenue may be lower, while the asset costs may be higher during these periods.
It may also assist in offsetting some of the expenditures associated with the development and development of a firm, which may encourage the owners of the business to reinvest in the company.
Tracking the value of an asset in a practical style can also be accomplished through the use of accelerated depreciation.
Disadvantages of Using Accelerated Depreciation Method
Following are the disadvantages of using accelerated depreciation method −
In the event that you sell your asset at a price that is greater than its accounting value, there is a possibility that your profit may be categorized as recaptured depreciation. This is known as the risk of recaptured depreciation. As a result, it is considered taxable income.
Growing companies may face difficulties as a result of their reduced future deduction.
What is Straight-Line Depreciation?
Straight-line depreciation is a popular form of depreciation in which the value of a fixed asset is lowered equally over the course of its useful life. Straight-line depreciation is one of the most prevalent types of depreciation. The technique was designed to provide an illustration of the consumption pattern of the item that was being considered. It is typically utilized in situations in which there is no discernible pattern to how one makes use of an asset over time. In addition to its application in accounting, it is also put to use in the process of calculating tax deductions.
Calculation
The formula to calculate straight-line depreciation is,
$$\mathrm{Straight\, line\, Depreciation\, =\, \frac{Purchase\, Price - Salvage\, Value}{Useful\, Life}}$$
The Purchase Price accounts for all of the expenses incurred throughout the process of purchasing and installing the asset, including those pertaining to labor, transportation, and taxes.
The Salvage Value is an estimate of how much it will cost to purchase the asset once it has reached the end of its usable life.
The number of years that a fixed asset is projected to be of use is referred to as the useful life of an asset. This number can be approximated or computed.
Advantages of Using Straight-Line Method of Depreciation
The advantages of using straight-line method to calculate depreciation are as follows −
Calculating depreciation using this method is the most straightforward approach.
In addition to this benefit, there will be fewer mistakes in the calculations as a direct consequence of using it.
It is possible to deduct the whole value of assets.
Appropriate for use in smaller enterprises.
Beneficial for holding assets with a lesser value.
Disadvantages of Using Straight-Line Method of Depreciation
Following are the disadvantages of using the straight-line method to calculate depreciation −
Does not have a plan in place to replace its assets
It is believed to be an irrational method of depreciation since it is thought to be illogical to depreciate the asset based on the initial cost while the balance of the asset depreciates every year. Consequently, this method of depreciation is not commonly used.
It is useless for an asset that has a long life and a high worth.
Given that the rate of depreciation remains constant throughout, this places an excessive burden on the asset's last years (the time when all the necessary repairs and maintenance have been completed).
Differences between Accelerated Depreciation and Straight-Line Depreciation
The following table highlights the major differences between Accelerated Depreciation and Straight-Line Depreciation −
| Characteristics | Accelerated Depreciation | Straight-Line |
|---|---|---|
| Definition | The accelerated depreciation technique permits the deduction of larger expenditures in the initial few years after the acquisition of an asset, with those expenses falling to lower levels as the item ages. | The cost of maintaining an item is proportionately reduced by using the straight-line method of depreciation. |
| Simplicity | The calculation for accelerated depreciation is more difficult than the calculation for straight-line depreciation. | The calculation of the straightline depreciation is a straightforward process that is not difficult to grasp. |
| Suitability | Accelerated Depreciation is beneficial for new firms that need to invest in a substantial amount of equipment as well as established companies that have significant capital outlays for equipment. | Small firms and assets with a lesser value are good candidates for the straight-line depreciation method. |
| Asset life consideration | Accelerated depreciation is appropriate for assets that are expected to have a long life and have a high value. | Straight-line is an appropriate valuation method for assets that have a shorter life and a lower value. |
Conclusion
Both the Straight-line technique and the Accelerated Depreciation method are effective approaches in determining the value of an asset over time, and both approaches are utilized in the context of tax deductions and accounting. You are free to select a technique to utilize in accordance with the nature of your company and the assets it owns. Now that you have this knowledge, you will be able to make an informed decision between the two approaches for managing your assets.
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