Depreciation is how companies recapture the cost of a long-term asset. Through depreciation, companies transfer the asset’s cost from the balance sheet to the income statement over a period of time. The type of asset, its useful life and the depreciation method used determines the length of time. Since accumulated depreciation reduces the value of the asset on the balance sheet, accelerated depreciation impacts income statement and balance sheet-based financial ratios.

## Accelerated Depreciation

The Internal Revenue Service has specific rules regarding the method of depreciation used and how to apply it. The method that the IRS recommends or mandates as the depreciation method for most situations is the modified accelerated cost recovery system, or MACRS. With MACRS, the asset depreciates faster in the earlier years of its useful life. Another accelerated depreciation method is the double declining balance method.

## Profit Margin

Profit margin is a financial ratio calculated from the income statement. The profit margin shows how much a company earned out of every dollar generated in revenue. When accountants use the term “profit margin,” they refer to net profit margin. The profit margin is calculated by dividing net profit, also called net income, by total sales. The accelerated rate of depreciation increases depreciation expense. The higher expense lowers the profit. Therefore, accelerated depreciation decreases the profit margin.

## Return on Assets

Return on assets reveals the percentage of net profit that a company earned on its average asset balances during the year. It is calculated by dividing net income by the average total assets during the year. Accelerated depreciation decreases net income, but it also decreases the book value of assets. For example, say net income for the year is \$200,000. Asset value at the beginning of the year was \$300,000 and at the end of the year it is \$330,000. Therefore, average total assets are \$315,000. The return on assets is 0.64.

## Debt to Assets

The debt-to-assets ratio is calculated by dividing a company’s total debt by its total assets. As an asset depreciates, its book value decreases by the amount of accumulated depreciation. Assuming debt levels stay the same, the debt-to-assets ratio would increase. For example, a piece of equipment that cost \$50,000 may have accumulated depreciation of \$24,000 after two years under MACRS. Therefore, the equipment’s book value would be \$26,000. If the company had \$40,000 of debt that remained relatively constant, the debt-to-assets ratio would change from 0.80 to 1.54.

## Debt to Equity

The debt-to-equity ratio is another financial ratio impacted by accelerated depreciation. It is calculated by dividing total debt by total equity, both figures found on the balance sheet. The debt-to-equity ratio provides the amount of assets financed by creditors versus the proportion financed by owners. Accelerated depreciation does not directly reduce equity. It does so indirectly by reducing net income, which reduces the amount of retained earnings.
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