What is the Annuity Method of Depreciation?

The annuity method of depreciation is a depreciation technique that focuses on achieving a constant rate of return on an asset. It is more likely to be used for more expensive fixed assets that are expected to have a long useful life. To employ the annuity method, follow the steps noted below. The annuity method is not endorsed by generally accepted accounting principles.

Step 1. Estimate Cash Flows

Estimate the future cash flows that will be associated with an asset.

Step 2. Calculate the IRR

Calculate the internal rate of return on those cash flows.

Step 3. Derive Depreciation

Multiply the internal rate of return by the initial book value of the asset. Then subtract the result from the cash flow for the current period. The residual value is the depreciation to charge to expense in the current period.