Fixed Asset Accelerated Depreciation Methods

Double Declining Balance Method and Units of Production Method

Sep 5, 2009 James Clausen

Accelerated depreciation can be used for tax benefits early on. The double declining balance and units of production methods are two methods of accelerated depreciation.

When purchasing fixed assets like buildings (not land), vehicles, equipment and machinery it’s important to determine what method of depreciation should be used as a tax deduction. The straight-line depreciation method is the most common method used. Accelerated depreciation can be especially useful when an asset creates more income early its useful life. Using this method can help offset some the extra income with tax deduction generated early on in the assets life.

Double Declining Balance Method of Accelerated Depreciation

This method will give a larger depreciation in the early years than the sum of the digits method of depreciation. The double declining balance method is used like the straight-line method expect that the first year's depreciation is double the percentage of the straight-line method. Each additional year in the life of the asset is multiplied by the same percentage of the remaining depreciation. Once the depreciation amount per year is less than the amount used by the straight-line method, the straight-line yearly depreciation is then used.

For example an asset purchase price is $10,500 with a salvage value of $500 and a useful life of 5 years. The straight-line method would be 20% a year (5 years / $10,000 = 20%) or $2,000 a year. Using the double declining balance method would be 40% per year of the remaining balance until the amount is less than $2,000. Once the amount the amount is less than $2,000 in a given year, $2,000 dollars or the lesser of the remaining must be used.

• Year 1 – $4,000 depreciation amount, 40% of $10,000 - $6,000 remaining value
• Year 2 – $2,400 depreciation amount, 40% of $6,000 - $3,600 remaining value
• Year 3 – $2,000 depreciation amount, 40% of $3,600 = $1,440 STOP. The depreciation amount is less than the straight-line method. The straight-line amount of $2,000 is to be used. The remaining value is now $1,600.
• Year 4 – $1,600 depreciation amount
• Year 5 – $0 depreciation amount

Units of Production Method of Depreciation

The unit of production method’s generally used for an asset that produces a product that generates income. Using this method doesn’t always result in a method for accelerated depreciation. This will only occur if the asset will produce more at the early stages of its life and decline in production over its life span. A unit of production method of depreciation is useful for balancing the tax burden of income versus the income generated by the asset.

To calculate the units of production method of depreciation there are 3 factors to consider

1. The depreciable value of the asset, asset cost minus salvage value
2. The life expectancy of the asset in years
3. The unit production for each individual year of the assets life

Using the example for the double declining balance method the depreciable value is $10,000 (1). The life expectancy of the asset is 5 years (2). The following is an example of calculating the unit of production method assuming a total unit production of 20,000 units (3) over the 5-year life of the asset. Unit cost of deprecation would equal $.50 per unit (20,000 units / $10,000 dollars).

• Year 1 – 6,000 units. Depreciation amount would equal $3,000 ($.50 x 6,000 units).
• Year 2 – 5,000 units. Depreciation amount would equal $2,500 ($.50 x 5,000 units).
• Year 3 – 4,000 units. Depreciation amount would equal $2,000 ($.50 x 4,000 units).
• Year 4 – 3,000 units. Depreciation amount would equal $1,500 ($.50 x 3,000 units).
• Year 5 – 2,000 units. Depreciation amount would equal $1,000 ($.50 x 2,000 units).

Since asset depreciation is recorded as an expense on the income statement, this can have a profound affect on reported profits. Depreciation also has an impact on the balance sheet and net worth of the company. There are many rules as to what types of depreciation methods are used depending on numerous factors. Before choosing and implementing a certain method of depreciation, it’s always best to consult a certified public accountant (CPA) to discuss what options are best.

Sources:

irs.gov

principlesofaccounting.com

The copyright of the article Fixed Asset Accelerated Depreciation Methods in Accounting is owned by James Clausen. Permission to republish Fixed Asset Accelerated Depreciation Methods in print or online must be granted by the author in writing.

Fixed Asset Accelerated Depreciation Methods

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