The annuity method of depreciation is a depreciation technique that focuses on achieving a constant rate of return on an asset. To employ the annuity method, follow these steps:
- Estimate the future cash flows that will be associated with an asset.
- Calculate the internal rate of return on those cash flows.
- Multiply the internal rate of return by the initial book value of the asset.
- 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.
The annuity method is not endorsed by generally accepted accounting principles. This approach is also called the compound interest method of depreciation.