Annuity Method of Depreciation Definition

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What Is the Annuity Method of Depreciation?

The annuity method of depreciation is simply a process utilized to cipher depreciation connected an plus by calculating its rate of return—just arsenic if it were an investment. It is commonly utilized with assets that person a ample acquisition price, agelong life, and a fixed (or astatine slightest constant) complaint of return.

This annuity method of depreciation requires the determination of the internal complaint of return (IRR) connected the currency inflows and outflows of the asset. The IRR is past multiplied by the archetypal publication worth of the asset, and the effect is subtracted from the currency travel for the play to find the existent magnitude of depreciation that tin beryllium taken.

Key Takeaways

  • The annuity method of depreciation, besides called the compound involvement method of depreciation, looks astatine however an plus depreciates by determining its complaint of return.
  • To cipher utilizing the annuity method of depreciation, you find the interior complaint of instrumentality (IRR) connected the asset's currency inflows and outflows, past multiply by the archetypal publication worth of the asset, past subtracted from the currency travel for the play of clip that is being assessed. 
  • This method of depreciation works particularly good for assets that are pricey upfront and are expected to past for galore years, specified arsenic spot oregon buildings that a institution mightiness lease.
  • On the upside, this method takes into relationship the involvement mislaid connected the wealth spent to bargain the asset, which galore depreciation methods don't do.
  • On the downside, the annuity method of depreciation tin beryllium hard to recognize and whitethorn necessitate predominant recalculations.

How the Annuity Method of Depreciation Works

The annuity method of depreciation is also referred to arsenic the compound interest method of depreciation. If the currency travel of the plus being depreciated is changeless implicit the beingness of the asset, past this method is called the annuity method.

Many methods of measuring depreciation neglect to instrumentality into relationship the involvement mislaid connected capital invested successful an asset. The annuity method of depreciation makes up for this deficiency. The annuity method assumes that the sum spent connected buying an plus is an concern that should beryllium expected to person a yield. The reasoning is that, had 1 invested an magnitude adjacent to the outgo of the plus elswhere, they would person earned immoderate benignant of instrumentality oregon involvement connected it.

As such, the involvement is charged connected the diminishing equilibrium of the asset. It is past debited to an plus relationship and besides credited to an involvement account, which is past transferred to a nett and nonaccomplishment account. The plus is past credited with a fixed magnitude of depreciation for each successive year. How overmuch depreciation is assigned is calculated by utilizing an annuity table. The magnitude that is depreciated depends connected the involvement complaint and the beingness of the plus successful question.

Calculating the Annuity Method of Depreciation

The annuity method of depreciation focuses connected figuring for a changeless complaint of instrumentality connected immoderate asset. It tin beryllium calculated utilizing these steps:

  1. Make an estimation of the aboriginal currency flows that are associated with an asset.
  2. Determine what the interior complaint of return will beryllium connected those currency flows.
  3. Multiply that IRR by the asset's archetypal publication value.
  4. Subtract the supra effect from the currency travel for the existent period.
  5. The effect of Step 4 volition beryllium the depreciation to complaint to disbursal successful the existent period.

This process yields the magnitude of depreciation that tin beryllium accounted for implicit a acceptable play of time.

The annuity method calculation tin besides beryllium expressed successful a formula:

Annuity = i × TDA × ( 1 + i ) n ( 1 + i ) − 1 n Depreciation = annuity − ( i × BVSY ) where: i = Interest rate percentage / 100 TDA = Total depreciation on amount n = Annuity number of years BVSY = Book value start of year \begin{aligned}&\text{Annuity}=\frac{i\times\text{TDA}\times(1+i)^n}{(1+i)-1^n}\\&\text{Depreciation}=\text{annuity}-(i\times\text{BVSY})\\&\textbf{where:}\\&i=\text{Interest complaint percentage}/100\\&\text{TDA}=\text{Total depreciation connected amount} \\&n=\text{Annuity fig of years}\\&\text{BVSY}=\text{Book worth commencement of year}\end{aligned} Annuity=(1+i)1ni×TDA×(1+i)nDepreciation=annuity(i×BVSY)where:i=Interest rate percentage/100TDA=Total depreciation on amountn=Annuity number of yearsBVSY=Book value start of year

Advantages and Disadvantages of the Annuity Method of Depreciation

The annuity method of depreciation is utile for assets that person a precocious archetypal outgo and a agelong beingness span, specified arsenic spot and buildings secured nether leases. It takes into relationship the involvement mislaid connected the wealth spent to bargain the asset, which galore depreciation methods don't do.

Some disadvantages of utilizing this method are that it can beryllium hard to recognize and that it whitethorn necessitate predominant recalculations depending connected the asset. Also, it tin beryllium burdensome to nett and nonaccomplishment accounting implicit time, arsenic the level of depreciation diminishes with each year.

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