Accelerated Depreciation

A second justification for accelerated depreciation is that some types of property and equipment lose value more

quickly in their first few years than they do in later years. Automobiles and other vehicles are a typical example

of this pattern. Recording a greater expense initially is said to better reflect reality.

Over the decades, a number of equations have been invented to mathematically create an accelerated depreciation

pattern, high expense at first with subsequent cost allocations falling throughout the life of the property. The most

common is the double-declining balance method (DDB). When using DDB, annual depreciation is determined

by multiplying the book value of the asset times two divided by the expected years of life. As book value drops,

annual expense drops. This formula has no internal logic except that it creates the desired pattern, an expense

that is higher in the first years of operation and less after that. Although residual value is not utilized in this

computation, the final amount of depreciation recognized must be manipulated to arrive at this proper ending

balance.

Depreciation for the building bought above for $600,000 with an expected five-year life and a residual value of

$30,000 is calculated as follows if DDB is applied.

(cost – accumulated depreciation) × 2/expected life = depreciation expense for period

Year One:

($600,000 – $0) = $600,000 × 2/5 = $240,000 depreciation expense

Year Two:

($600,000 – $240,000) = $360,000 × 2/5 = $144,000 depreciation expense

Year Three:

($600,000 – $384,000) = $216,000 × 2/5 = $86,400 depreciation expense

Year Four:

($600,000 – $470,400) = $129,600 × 2/5 = $51,840 depreciation expense

Year Five:

($600,000 – $522,240) = $77,760,

so depreciation for Year Five must be set at $47,760 to arrive at the expected residual value of $30,000. This final

expense is always the amount needed to arrive at the expected residual value.

Note that the desired expense pattern has resulted. The expense starts at $240,000 and becomes smaller in each subsequent period.

When using accelerated depreciation, book value falls quickly at first because of the high initial expense levels.

Thus, if the asset is sold early in its life, a reported gain is more likely. For example, in the earlier example where

straight-line depreciation was applied, the building was sold after two years for $290,000 creating an $82,000 loss

because the book value was $372,000. The book value was high in comparison to the amount received.

With DDB, if the same building had been sold on December 31, Year Two for $290,000, a $74,000 gain results

because book value has dropped all the way to $216,000 ($600,000 cost less $384,000 accumulated depreciation).

Accelerated depreciation creates a lower book value, especially in the early years of ownership.