Accelerated Depreciation

Posted in Finance, Accounting and Economics Terms, Total Reads: 3190
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Definition: Accelerated Depreciation

Accelerated Depreciation refers to a method in which an organization depreciates its fixed assets in such a way that it allocates unequal amounts for each year.  This primarily means that a larger portion of the cost is written-off in the earlier years while a lesser amount is left towards the end.

As depreciation is a non-cash expense, this method of depreciation is only for the financial reporting and tax purposes and has no impact on the cash flows. The benefit that a company gains out of this is that its tax expense is deferred onto a later period which is better as per the concept of time value of money.

There are several methods which can be used for the accelerated depreciation like the Double Declining Balance method (DDB), Modified Accelerated Cost Recovery System (MACRS). Accelerated depreciation is generally used for assets which are often replaced before their useful life so that they are completely written-off by the time they are replaced.


Example

Cost of an asset = Rs. 1000

Useful life of the asset = 10 yrs.

As per Straight line depreciation, Depreciation per year = 1000/10 = Rs. 100

Assume tax rate = 20%

Assume profit each year = Rs. 200

Now, company pays tax of 0.2*(200-100) = Rs. 20 each year

As per Accelerated Depreciation,

Assume that the company allocates Rs. 200 for the first five years and no depreciation in the next 5 years

Tax paid in the first five years = 0

Tax paid in the next five years = 0.2*200 = Rs. 40

Though the total tax paid is same but the tax payment has been deferred to the last five years which is significantly better as per the time value of money. Hence, depreciation serves as a tax shield.


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