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What is Accelerated Depreciation and how is it measured?
In Accelerated Depreciation, a capital asset loses its face value faster in an earlier year in comparison to later years. It is a process where the net value of depreciation in beginning is the highest while it gets reduced increasingly as the asset ages. This is not applicable to traditional methods such as the Straight Line Method. In the straight-line method, the rate of depreciation remains the same over the entire life of the asset.
Due to accelerated depreciation, a company reports less profit as it pays more for the asset in earlier years. This profit goes up gradually as the asset ages as net depreciation goes down. It means that the company reports the least amount of depreciation in the last year of the assets life than in any other year. It naturally increases the profits of the company.
Types of Accelerated Depreciation Methods
We have two different methods to calculate Accelerated Depreciation −
Double Declining Balance (DDB) Method
In DDB, the reciprocal of an asset's useful life is doubled and used applied to a depreciable base. This gives the remaining life of the asset.
DDB is calculated by the formula −
Double declining balance = 2 × Straight-line depreciation rate × Book value at the beginning of the year
Sum of Years' Digits (SYD) Method
In SYD, all the digits of the asset's entire lifetime are added and used as a base for each reducing year.
SYD is given by −
Applicable percentage (%) = Number of years of estimated life remaining at the beginning of the year / SYD
For example, if the total lifetime of an asset is 4 years, the total of their sum is 1+2+3+4=10.
Now, 4/10 of the asset will be considered in the first year, 3/10 in the second year, etc., and the process will be carried on to get the 1/10 value of the asset.
Tax Deductions and Improved Net Present Value (NPV)
Managers are often interested in reducing the tax levied on an asset and accelerated depreciation helps them doing this in earlier years of an asset. As is obvious the tax rate is the same for the entire life of an asset. So by using the accelerated depreciation methods, tax can be saved.
Lower NPV is achieved by businesses who consider the time value of money which means it is better to save money earlier than later. Thus accelerated depreciation saves tax and improves the NPV of a business.
Points to Note
Accelerated depreciation method attaches more depreciation in earlier years than later years of an asset.
Double Declining and Sum of Years' Digits methods are popular accelerated depreciation methods.
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