The tax impact of accelerated depreciation
/What is Accelerated Depreciation?
Accelerated depreciation is the depreciation of fixed assets at a faster rate early in their useful lives. This is done to recognize the increased usage experienced by some assets early on, as well as to reduce the amount of taxable income over the first few years of an asset’s useful life.
Understanding the Tax Impact of Accelerated Depreciation
When a business includes accelerated depreciation on an income tax return, this reduces the amount of taxable income early in the life of a fixed asset. However, this leaves a reduced amount of depreciation that can be charged later in the life of the asset, which results in more taxable income in later years. Though these timing differences appear to balance each other out, the use of accelerated depreciation will defer the payment of some income taxes to later periods. Under the time value of money concept, where money paid out later has a lower present value than money paid out sooner, this deferral of payments is of value to the business.
An organization may elect to use the straight-line method of depreciation when creating its financial statements, while using accelerated depreciation to compile its tax returns. The resulting difference in taxable income will create a timing difference between the two reports in regard to the recognition of income, which is known as a temporary difference.