Accelerated Depreciation

What Is Accelerated Depreciation?

Accelerated depreciation can be defined as an improvement in the cost of an asset, recognizing that the same asset’s value will decrease with time due to wear and tear, environmental factors, and construction changes. Businesses can qualify for accelerated depreciation when certain criteria are met. These criteria vary based on whether the asset is professional or industrial, determining if the asset is subject to repair and maintenance. The basic idea behind accelerated depreciation is to reduce your asset’s overall cost to that of the time value of capital.

This form of depreciation allows businesses to deduct a portion of their current cost before taxing that item at the normal rate. Under certain circumstances, businesses can claim more deductions than they otherwise could. Using an accelerated depreciation allows you to take advantage of tax breaks normally only available in limited situations.

Understanding Accelerated Depreciation

Accelerated depreciation is a method by which a corporation can reduce the value of its tangible assets over time. This reduces the cost of maintaining and operating these assets while maximizing the potential profits each year.

Accelerated depreciation allows a company to reduce its depreciable lifetime by a number of years, based on either the length of time that you own the asset or perhaps the product that you are selling. This means the longer you own an asset, or the longer you hold onto a given product or service, the more benefit you will receive from accelerating its depreciation.

Accelerated depreciation can also help cover short-term business expenses. For example, if your company purchases a large truck but does not have enough money to pay for the upfront purchase cost of the vehicle, then you may be able to claim the full amount of the purchase price as a write-off against your income for the year. This is true even if you sold the item (for example, if you got cashback for it) because although the business would have paid less in taxes for the year, the amount that you paid for it (the difference between the purchase price and your current market value) was not taxed until you spent it.

Sum of the Years’ Digits (SYD)

To determine the depreciation expense for a depreciable asset, the sum-of-years’ digits method is used. The initial step in this method is to add together all of the digits in the asset’s estimated useful life. Sum of the Years’ Digits (SYD) is a formula that allows your accounting team to depreciate a fixed asset (tangible or intangible) faster than you normally do. To determine the depreciation amount, you take the base and subtract 1 plus 2 plus 3 plus 4 and 5. During each subsequent year, 5% of the depreciable base will be next year’s depreciation deduction.

Double-Declining Balance Method

The double-declining balance method is an accelerated depreciation method used to compute the value of a long-lived asset by reducing the remaining book value at an increasing rate per period (depreciation).

A double-declining balance method is used to calculate depreciation for assets. It uses the straight-line method over twice as many periods, thus giving greater annual depreciation. At the end of the first period, two times (2X), the original depreciation amount is deducted from the original cost. At the end of each successive period, the amount deducted is reduced by 20% (1/5) of the amount deducted in either of the previous periods.

Example of Accelerated Depreciation

The basic concept behind accelerated depreciation is that, in most cases, real property begins to lose value faster than it gains value. Because of this, accounting rules allow companies to accelerate the depreciation of real estate assets held for longer periods by claiming a basis reduction. This reduces an asset’s basis (sometimes substantially) but leaves it in effect for the asset’s life even if it has appreciated. For example, assume you bought a house for $100,000 ten years ago, and it has appreciated to $150,000 at the end of ten years. If you had owned the house at its original purchase price, you would have to pay taxes on the $15,000 gain you earned during that period. However, because you accelerated the depreciation by spending $20,000 on improvements to the property, your taxes will be zero on that gain because it has been treated as if it were earned during the first year.

Example of the Double Declining Balance Method

let’s say your balance is $100, and you have a $50 credit card (the cheapest credit card you can get). If you buy a $50 gift card at the supermarket with your $100, you will have to pay off the balance on the next $50 ($200 in total payments) to have $100 available for use at the end of the month.

Example of the Sum of the Years’ Digits Method

Say you have a house that’s worth $100,000, and you’ve been paying $50 a month in payments since 2010. After 10 years, your payments would equal $1,100,000 – $50 = 1,000,000. This is how a typical 10-year house payment method works.

When Not to Use Accelerated Depreciation?

While accelerated depreciation is required for most companies that depreciate property, some companies might choose not to use it. This can be because they don’t want to do the bookkeeping or earn taxable income. Accelerated depreciation is a complex technique that requires detailed record-keeping, so many companies seek fixed asset software to make the process easier and less time-consuming.

Corporations with limited fixed assets may not wish to focus on accelerated depreciation, since it does not significantly impact the tax rate. Determining whether to use accelerated depreciation depends largely on the nature of your business. If you are a publicly held company, investors will be generally interested in high reported earnings, so you may not want to use accelerated depreciation.

Benefits of using Accelerated Depreciation

The benefits of using an accelerated depreciation method include increased tax savings for business owners and the ability to offset the cost of a new business asset or business growth. This helps a company remain competitive in the marketplace by reinvesting back into itself.

Accelerated depreciation is a method of reporting income more realistically and accurately. Accelerated depreciation accounts for both the rate at which an asset loses its value and that assets are replaced more quickly than they wear out.

When to use Accelerated Depreciation?

Accelerated depreciation is an accounting method that allows businesses to write off equipment more quickly than standard depreciation. It is most commonly used in the early start-up phase when a business has a substantial need for new equipment and is quickly expanding or by businesses that experience cyclical growth or contraction over time due to local economic factors. You can cut back on taxes by accelerating your depreciation expense at the end of the year. In turn, you’ll be able to reinvest more capital back into your business. This can help you accelerate your growth and allow you to hire new employees.

Is Accelerated Depreciation Allowed Under GAAP?

Generally accepted accounting principles, or GAAP, are standards defined by the professional accounting industry. The objective of those standards is to provide established criteria for financial reporting that covers a wide variety of business and financial transactions consistently and transparently. The bottom line is that GAAP establishes rules that define how public companies must report their financial information.

With the Section 179 and Modified Accelerated Cost Recovery System disallowed for financial reporting purposes, other accelerated depreciation methods, including Double Declining Balance (DDB) and Sum of Years Depreciable (SYD), are used instead of the former two methods.

What is MACRS?

MACRS, or Modified Accelerated Cost Recovery System, is a system for deducting the cost of capital assets. The US Tax Code allows deductions for most types of capital expenditures over a set period. The Modified Accelerated Cost Recovery System is a method used by companies to depreciate assets. It allows the expenses for assets to be recovered over time and reduces the tax burden. This way, companies have a better financial outcome.

The Modified Accelerated Cost Recovery System (MACRS) allows businesses and individuals to recover the cost of most assets over a short period. There are two systems under the MACRS:

GDS stands for General Depreciation System with the larger deductions in early years. On the other hand, ADS represents Accelerated Depreciation System which has less deduction year over year.

For an asset to be depreciated using MACRS, it must first be classified as either tangible or intangible. The asset’s classification determines which of the two systems, MACRS or Alternative Depreciation System (ADS), must be used. After classifying the asset and determining which system to use, companies must consult IRS Publication 946 to identify the correct depreciation.

Conclusion

Accelerated depreciation is an important accounting tool that every business in any country should know about. An indebted company commonly uses them to save more than 100% of its realized capital gains from sales and use it rather than write it off against income or pay taxes on it.