Accelerated Depreciation Method
Accelerated depreciation is a method used in accounting for costs and assets. Through depreciation a company’s accounting reflects the fact that the assets the company holds (for example some machines used in producing the output) decrease in value over time (as they get old and their condition may deteriorate through using them). Technically depreciation is a decrease in asset‘s value in the accounts which at the same time is recorded as a (non-cash) cost or an expense.
Depreciation is often made evenly over the life of the asset – such depreciation method is called straight-line depreciation. For example in the beginning the company purchases a machine for 1 million dollars and it expects to use it for the next 5 years. Therefore the company’s accountants will every year decrease the value of the machine by one fifth or 200,000 and these 200,000 will be recorded as costs in that year.
But in some cases the accelerated depreciation method can be used and as the name suggests, the asset’s value will now decrease faster in the early years and slower in the end of the asset’s life. In our example, instead of 5 times 200,000 the depreciation can be 300,000 in the first year, and in the following years it can be 250,000 – 200,000 – 150,000 – 100,000. As a result, the company will show higher costs and therefore a lower profit in the first years and lower costs and higher profits in the later years.
Accelerated Depreciation and Taxes
Companies like using accelerated depreciation for tax purposes, because it makes their profits (calculated for tax purposes) in the early years smaller and in this way they can pay part of their taxes later. Of course the pre-tax cash flow is unaffected, as depreciation is a non-cash expense. Using accelerated depreciation for tax purposes is subject to rules and regulation.