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Accelerated Depreciation

Accelerated Depreciation

Author: Evan McLaughlin

In this lesson, the student will learn about accelerated depreciation.

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"Accelerated Depreciation"

Source: Instrumental “Drops of H2O ( The Filtered Water Treatment )" by J.Lang (feat. Airtone),” Creative Commons, http://ccmixter.org/files/djlang59/37792; all tables and graphs created by Evan McLaughlin

Video Transcription

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[MUSIC PLAYING] Hey everyone, and welcome to our video today on accelerated depreciation. So what's today's video all about? Well, we're going to talk about accelerated depreciation. We're going to talk about some of the different methods of accelerated depreciation. And then we're going to specific we look at an example of one method called double declining balance. And we're going to look at an example of calculating depreciation using double declining balance.

But let's start with talking about accelerated depreciation. So when should it be used? Well, if we have assets that are used more heavily in their earlier years is a good situation when we should use accelerated depreciation. So these are assets that lose their functionality over time. So they're more heavily used in the earlier years. They contribute more to production during their earlier years, and they lose functionality over time.

An example would be vehicles. So vehicles are going to be more heavily used in those earlier years. And as that wear and tear starts to catch up with it, it loses functionality over time.

What are the benefits of accelerated depreciation? Well there's a reduced time period. So there's a reduced time period for write-off of an asset's cost. So you're writing off that asset over a shorter period of time.

Now, what does that help with? Well, it helps to reduce taxes. So in the earlier years of that asset's life you're going to have reduced taxes because you're recording a higher level of depreciation. OK? So you're recording a greater expense so that's going to help to reduce your taxes.

What types of accelerated depreciation are there? What methods of accelerated depreciation do we have? Well, there's MACRS and ACRS, sum of the year's digits, units of production, and double declining balance.

Let's talk a little bit more about these specific types of accelerated depreciation. So starting with MACRS and ACRS. MACRS is modified accelerated cost recovery system. And ACRS is accelerated cost recovery system. These are used when reporting information to the IRS. So when you're doing your taxes you we need to use MACRS and ACRS as your depreciation method.

Sum of the year's digits. Let's take a look at the formula to calculate depreciation using sum of the year's digits. So you would take the remaining life of that asset as of the beginning of the year. So your remaining life as of the beginning of the year. And divide it by the sum of the years of the useful life.

Now, what does that mean? Well, if we have an asset that has a five-year useful life, our denominator is going to be 5 plus 4 plus 3 plus 2 plus 1 or 15. So that's how we would set up the calculation for sum of the year's digits. And that's where it gets its name.

The other method, units of production, this is beneficial for machinery. So if you have machinery that's used in your production process, it might have a useful life expressed in hours. So the number of hours it can be in that production process or even the number of units that it can produce.

So if we take a look at the formula for units of production, we would take our depreciable base, multiply it by the hours this year, so the hours that that asset was used during the year, and divide it by the total estimated hours for that asset. And again, this can also be used for units. So you would take depreciable base, multiply it by units this year, divide it by total estimated units. So that's units of production.

And last, but certainly not least, is our double declining balance. Now this is the most common accelerated depreciation method. And one interesting thing about the double declining balance method is that it does not deduct the salvage value when computing the depreciable base.

So to explain double declining balance, let's go ahead and take a look at an example of calculating that depreciation method. OK, everyone so what we're going to be doing here is calculating depreciation using the double declining balance method. So the first step we need to do is determine the straight line rate of depreciation for the year. So our straight line depreciation in this case, we're going to take an asset with a total book value of 500,000 and a useful life of five years.

Now, our straight line depreciation would be $100,000 per year. So we divide 500,000 by 5. Now we need to express that as a percentage. So our straight line depreciation percentage is 20%. So 20% each year under the straight line method would be our depreciation.

So then, step two is to multiply that straight line depreciation rate by 2. And that gives us our double declining balance rate. So now we have the rate for our double declining balance. So now we can start preparing our depreciation schedule.

So now we're going to start preparing this depreciation schedule. So we're going to have these columns-- the year, book value at the beginning of the year, our depreciation rate, depreciation expense accumulated depreciation, then our book value at the end of the year.

So step three is to take that double declining balance depreciation rate and apply it to our asset. So we apply it to the initial value. And in the subsequent years, we apply that double declining balance rate to the carrying value at the beginning of the year.

So you'll see here, the beginning of the year in year two, our book value is the same book value that we ended the first year with. So we would do this for all five years. And then you'll see here at the end of year five, we have a book value at the end of year five at 38,880.

OK. So one more thing to look at is we have the same example facts as before, only now we've added production life for our units of production method, as well as the production hours over the course of the life of this example asset. And what we're going to do is we're just going to look at the comparison of these three depreciation methods-- double declining balance, sum of the year's digits, as well as units of production.

So you'll see that starting with that double declining balance, in the early years the depreciation is greater and then starts to taper off towards the end of that asset's useful life. In sum of the year's digits it's going to be a very linear downward sloping line because it's systematically decreasing over time.

And then, lastly, units of production, again, that's based entirely on the amount of production. So depending on the production over time, that's what that depreciation is going to look like. So there might be spikes in depreciation, and then as that asset starts to age, its productivity is going to decrease. So that's a comparison of these three accelerated depreciation methods.

Great. So now that we've seen a calculation of double declining balance, and then we've also seen a comparison of some of these accelerated depreciation methods, let's summarize what we talked about today. In a nutshell, we talked about accelerated depreciation. We looked at MACRS and ACRS, sum of the year's digits, units of production. And then we focused a little bit more on double declining balance. We looked at an example of calculating that.

I hope everybody enjoyed this video. And I hope to see you next time.