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Topics: Depreciation, Asset, Generally Accepted Accounting Principles Pages: 16 (4335 words) Published: February 25, 2014
Journal of Finance and Accountancy

The sum-of-years’ digits depreciation method: use by SEC filers Thomas R. Noland
University of Houston
Abstract
The sum-of-years’ digits depreciation method is an accelerated depreciation and amortization technique that is acceptable for financial reporting under U.S. and IASB accounting rules. Until 1981, it was an acceptable method for tax reporting in the U.S., and the aggressive nature of the method was an appealing characteristic for tax returns. Since 1981, little attention has been paid to its continued use in financial reporting. Academic research tends to group all accelerated depreciation methods together. However, declining balance depreciation methods are more appealing because they are more flexible, are easier to apply to partial periods, and have common characteristics with current U.S. tax depreciation law. This paper reports how SEC filers over the past four years have used the sum-of-years’ digits method. It shows what type of companies use this method, what types of assets it is applied to, and what length of asset life is typically chosen. Sum-of-years’ digits sees its most frequent use in the banking and regulated industries. It is primarily applied to intangible assets, such as acquired customer relationships. What is surprising for the non-regulated companies is that they are amortizing the assets more aggressively for financial reporting than they are for tax reporting. Possible motivations are discussed.

Keywords: sum-of-years’ digits, accelerated depreciation, intangible assets, financial reporting

The sum-of-years’ digits depreciation, Page 1

Journal of Finance and Accountancy
INTRODUCTION
Sum-of-years’ digits is an acceptable depreciation and amortization method for use in financial reporting under U.S. generally accepted accounting principles (GAAP). The method is typically not taught in undergraduate introductory financial accounting courses (Albrecht, Stice, and Stice, 2008; Warren, Reeve and Duchac, 2007; Weygandt, Kimmel and Kieso, 2008), but is covered in intermediate financial accounting courses (Kieso, Weygandt and Warfield, 2010; Nikolai, Bazley, and Jones, 2010; Stice, Stice and Skousen, 2008). While there is a general belief that it is not commonly used in practice (Kieso, Weygandt, and Warfield, 2010, p. 542), no detailed analysis has been done in terms of the extent of use, the types of companies that use it, or the assets it is typically used with. For expositional ease, the remainder of the paper will use “depreciation” to refer to either the depreciation of tangible assets, or the amortization of intangible assets.

Prior to 1981, the methods available for tax depreciation were essentially the same as for financial reporting. Sum-of-years’ digits was one of many acceptable methods of cost allocation. Academic research often focused on optimizing depreciation allocation (Schwab and Nicol, 1969; Sunley, 1971; Lere, 1980). From a regulatory perspective, conflicts most frequently arose from disagreements between taxpayers and the IRS over estimated useful lives. Companies preferred short asset lives to take maximum advantage of the depreciation tax shield. In 1971, the optional Class Life System was implemented. The system specified useful lives for different categories of assets. If a company depreciated an asset using the Class Life System estimated life, the IRS would not challenge it. Many companies, however, did not choose this option, and conflicts persisted. The depreciation issue was addressed again in the Economic Recovery Tax Act of 1981. This act introduced the Accelerated Cost Recovery System (ACRS) that specified both the life of the asset and the depreciation rate for tax purposes. At this point, sum-of-years’ digits was no longer acceptable for tax purposes. The ACRS system has been modified several times since 1981 and is referred to as MACRS. At no time, since 1981, have companies been allowed to use sum-of-years’...

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