What it means
Straight-line depreciation charges the same amount every year, which is simple but does not match how most assets behave. A delivery van loses far more value in its first year than its fifth, and a machine usually does its most productive work when new.
Accelerated methods front-load the charge to reflect that pattern. The two most common are the reducing balance method, which applies a fixed percentage to a shrinking carrying value, and sum-of-the-years' digits, which applies a declining fraction to the original cost.
The commercial attraction is tax deferral rather than tax saving. Bigger deductions early mean less tax paid early, and money kept in the business in those years is worth more than the same money paid later, even though total tax over the asset's life is identical.
Many businesses therefore run two sets of numbers: accelerated depreciation on the tax return and straight-line in the published accounts, which are meant to show a fair view of how the asset is consumed. The gap between the two creates deferred tax, a liability recording tax postponed rather than avoided.
The trade-off is a lumpy profit profile. Early years carry heavy depreciation and look weaker, later years look stronger, and a business that buys a lot of equipment in one year can find its reported profit depressed for reasons that have nothing to do with trading.
In practice
Real-world examples
Example 1
A haulage firm buys $600,000 of trucks and claims accelerated allowances, cutting taxable profit in year one by $240,000 rather than the $120,000 straight-line would give. The extra $120,000 of deduction defers $30,000 of tax at a 25% rate, which funds the deposit on a further vehicle.
Example 2
A technology company depreciates servers over three years on a reducing balance basis because their useful life genuinely is front-loaded. Finance and operations agree the pattern matches reality, so the same method is used in the accounts and in the tax computation.
Example 3
A restaurant group's reported profit falls 18% in a year it fitted out four new sites. The accelerated write-off on the fit-out is the whole explanation, and the bank agrees to test its covenants on earnings before depreciation instead.
Think of it
Imagine eating an ice cream cone on a hot day. You take bigger bites right at the start so you enjoy the most benefit before it melts, rather than eating equal tiny bites until it is gone.
Formula
Calculation
Double declining balance rate = 2 / useful life in years
Annual charge = rate x carrying value at the start of the year
Sum-of-the-years' digits charge = (remaining life / sum of the digits) x depreciable cost
A printing business buys a press for $100,000 with a five year life and no residual value. Straight-line depreciation would be $100,000 / 5 = $20,000 every year, while the double declining rate is 2 / 5 = 40%.
Year one charges 40% x $100,000 = $40,000, leaving a carrying value of $60,000. Year two charges 40% x $60,000 = $24,000, leaving $36,000, and year three charges 40% x $36,000 = $14,400, leaving $21,600, which is then written off evenly across years four and five at $10,800 each.
Adding up: $40,000 + $24,000 + $14,400 + $10,800 + $10,800 = $100,000, exactly the same total as straight-line. The difference is timing, and at a 25% tax rate the extra $40,000 - $20,000 = $20,000 of deduction in year one defers $5,000 of tax that the business keeps and uses in the meantime.Case study
Seen in the real world
This is an illustrative and clearly fictional scenario. Tarrow Fabrication, an invented metalworking business, invested $2,000,000 in machinery and elected for accelerated depreciation on its tax return while keeping straight-line in its published accounts. Over the first two years the tax computation absorbed $800,000 + $480,000 = $1,280,000 of the cost against 2 x $400,000 = $800,000 in the accounts.
The $1,280,000 - $800,000 = $480,000 difference deferred $120,000 of tax at a 25% rate, which the fictional finance director used to fund working capital through a period of rapid growth. She also booked a deferred tax liability of the same $120,000, so nobody mistook a postponement for a permanent gain.
By year four the position reversed: the accounting charge exceeded the tax charge and the deferred tax liability began to unwind. Because Tarrow had planned for it, the higher tax bill surprised nobody, which is the difference between using accelerated depreciation and being caught out by it.
Watch out
Common mistakes
- Believing accelerated depreciation reduces the total tax paid over an asset's life, when it only changes when that tax falls due.
- Ignoring the deferred tax liability that builds up, then treating the later reversal as an unexpected tax rise.
- Applying an accelerated pattern to assets such as buildings that genuinely lose value slowly, which distorts the accounts.
Questions
People also ask
Which method should a business choose?
Reducing balance suits assets that lose value fastest when new and straight-line suits assets consumed evenly, though tax rules may dictate the answer for the tax return regardless.
Does accelerated depreciation affect cash flow?
Not directly, since depreciation is not a cash cost, but it changes the tax bill and therefore the cash actually paid out.
Can the accounts and the tax return use different methods?
Yes, and they very often do, with the gap recorded as deferred tax so the accounts still show the full eventual liability.