ACCELERATED
DEPRECIATION
Principles of Accounting II
Created 2007
By Michael Worthington
Elizabeth City State University
Accelerated Depreciation
• Define accelerated depreciation
• Discuss why companies choose
accelerated depreciation
• Discuss Consistency
• Compute declining balance
• Discuss Rule of 78
• Compute Sum-of-the-Years Depreciation
Define Accelerated Depreciation
“Accelerated” means that depreciation expense
is faster than _____________________________________
Accelerated methods have more depreciation
expense than SL at the beginning, and then less
at the end
Year
1.
2.
3.
4.
Total
EXAMPLE
Accelerated
$12,000
$ 9,000
$ 6,000
$ 5,000
$ 32,000
Straight-Line
$ 8,000
8,000
8,000
8,000
Total $ 32,000
1
Bar Charts of Depreciation
Straight-Line Depreciation
10000
8000
Years
Dollars
Accelerated Depreciation
14000
12000
10000
8000
6000
4000
2000
0
6000
4000
2000
0
1
2
3
Year
4
1
2
3
4
Dollars
The total amount of depreciation is the same for
either method—it’s all about timing—when to record
the depreciation expense
Why Companies Choose
Accelerated Depreciation
1. Accelerate income tax deductions to
reduce income taxes (minor effect)
2. Balance out _____________ expenses
Accelerated Depreciation amounts
decrease over time
Repair Expense amounts increase
over time
3. Approximate Economic Depreciation
Discuss Consistency
Firms must use the same depreciation
method from year to year so that
investors can look for trends over time
However, different classes of fixed
assets may use different methods
Examples: automobiles, furniture,
factory equipment, buildings, etc.
2
Discuss Declining Balance
“Book Value” means the net amount
shown on the accounting books
_____ Value = Cost – Accumulated Deprec
Book Value must always equal or exceed
Residual Value
1. Compute Declining
Balance Depreciation
Declining Balance Constant = % x 1/life
% is given, such as 200% for
“Double Declining Balance” (DDB)
DB Deprec = Constant x Book Value
Recompute Book _______ each period
Table to Compute DB
Beginning
Book Value
Depreciation
Expense
Ending
Book Value
Initial
Book Value
always
equals cost
Beginning
Book Value
times the DB
Constant
Beginning
Book Value
minus the
Depreciation
Next year’s
Final year’s
Book Value
depreciation
equals previous = Beg BV-RV
ending Book
Value
Ending Book
Value MUST
NOT be less
than Residual
Value
3
2. Formula for Final
Period’s Depreciation
Final Period DB Depreciation = BV - RV
After every computation,
determine if BV > or = RV
If BV < RV, then use the Final Period’s
Formula instead of using DB __________
Example of Declining
Balance Depreciation
Cost = $120,000
Life = 5 years
Residual Value = $45,000
Method = Double Declining Balance
Constant = 200% x 1/5 = .40 or 40%
1st Depreciation = .40 x $120,000 = $48,000
Initial Book Value always equals Cost
Book Value = Cost – Accumulated __________
Book Value = $120,000 - $48,000 = $72,000
Example of Declining
Balance Depreciation
Cost = $120,000
Life = 5 years
Residual Value = $45,000
Method = Double Declining Balance
2nd Depreciation = .40 x $72,000 = $28,800
Book Value = Cost – Accumulated Deprec
Book Value = $120,000 - $76,800 = $43,200
Book Value MUST > or = Residual Value
4
Example of Declining
Balance Depreciation
Cost = $120,000
Life = 5 years
Residual Value = $45,000
Method = Double Declining Balance
Final Period’s Calculation:
Deprec = Book Value – Residual Value
Deprec = $72,000 – $45,000 = $27,000
Example of Declining
Balance Depreciation
Cost = $120,000
Life = 5 years
Residual Value = $45,000
Method = Double Declining Balance
Year
Beginning
Ending
Book Value Depreciation Book Value
1
$120,000
$ 48,000
$ 72,000
2
$ 72,000
$ 27,000
$ 45,000
No depreciation in following years
Your Turn
Cost = $60,000
Life = 3 years
Residual Value = $15,000
Method = Double Declining Balance
Year
1
Beginning
Ending
Book Value Depreciation Book Value
$60,000
How much is depreciation?
5
Your Turn
Cost = $60,000
Life = 3 years
Residual Value = $15,000
Method = Double Declining Balance
Year
Beginning
Ending
Book Value Depreciation Book Value
1
$60,000
2
$20,000
???
$40,000
$20,000
But is the Ending BV >= to RV?
Your Turn
Cost = $60,000
Life = 3 years
Residual Value = $15,000
Method = Double Declining Balance
Year
Beginning
Ending
Book Value Depreciation Book Value
1
$60,000
2
$20,000
???
$40,000
$20,000
How much is the final year’s depreciation?
Discuss Rule of 78
1
2
3
Sum of the “digits” for
4
twelve months = 78
5
6
Denominator = 78
7
8
Numerator = count
9
backwards from 12 to 1
10
11
12
Sum = 78
6
Rule of 78
January = 12/78
February = 11/78
10/
March =
78
9/
April =
78
8/
May =
78
7/
June =
78
6/
July =
78
5/
August =
78
September = 4/78
3/
October =
78
November = 2/78
December = 1/78
Sum-of-the-Years’-Digits
First compute depreciable value
= Cost – Residual Value
Multiply depreciable cost by fraction
Numerator = count backwards
Denominator = sum of the digits
for the life of the asset
Example of Sum-of-the-Years’ Digits
Cost = $50,000
Life = 4 years
Residual Value = $10,000
Depreciable Cost = Original Cost – RV
Depreciable Cost = $50,000 - $10,000 = $40,000
Sum of the years’ digits = 1 + 2 + 3 + 4 = 10
First Year
Second Year
Third Year
Fourth Year
=
=
=
=
4/10
3/10
2/10
1/10
*
*
*
*
$40,000
$40,000
$40,000
$40,000
=
=
=
=
7
Example of SYD Depreciation
Cost = $50,000
Life = 4 years
Residual Value = $10,000
Year
Beginning
Ending
Book Value Depreciation Book Value
1
$50,000
$ 16,000
$ 34,000
2
$34,000
$ 12,000
$ 22,000
3
$22,000
$
8,000
$ 14,000
4
$14,000
$ 4,000
$ 10,000
SUMMARY
• Accelerated Depreciation is faster than
Straight-Line Depreciation
• Reasons for accelerated depreciation
(1) Taxes, (2) Repair Exp, (3) Economic
• Depreciation Methods must be consistent
from year to year
• Declining balance constant = % x 1/life
• Depreciation = Book Value x constant
• Final Period Depreciation = BV - RV
• Rule of 78 used to “short rate” insurance
• Sum-of-the-Years Depreciation is rare
8