Journal of Finance and Accountancy
The sum-of-years’ digits depreciation method: use by SEC filers Thomas R. Noland
University of Houston
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
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’...
References: Albrecht, W. S., Stice, E., and Stice, J. (2008). Financial Accounting (10th ed.). Thomson:
Archibald, T. (1972). Stock Market Reaction to the Depreciation Switch-Back. Accounting
Review, 47(1), 22-30.
Barefield, R and Comiskey, E. (1971). Depreciation Policy and the Behavior of Corporate
Bowen, R., DuCharme, L., and Shores, D (1995). Stakeholders ' implicit claims and accounting
method choice, Journal of Accounting and Economics, 20 (3), 255-295.
Beaver, W., and Dukes, R. (1973). Interperiod Tax Allocation and -Depreciation Methods: Some
Butler, G., and Crawford, L. (2001). The impact of price controls on accounting policy choice:
an international study of depreciation methods in the electricity industry
Issues in Accounting Regulation (2001), 187-198.
Comiskey, E. (1971). Market Response to Changes in Depreciation Accounting. Accounting
Review, 46(2), 279-285.
Fields, T., Lys, T., and Vincent, L. (2001). Empirical research on accounting choice. Journal of
Accounting and Economics, 31(1-3), 255-307.
Financial Accounting Standards Board. (2010). Accounting Standards Codification.
Financial Accounting Standards Board. (1985). Accounting for the Cost of Computer Software
to be Sold, Leased, or Otherwise Marketed, Statement of Financial Accounting Standards
Hatfield, H. (1944). Replacement and book value. Accounting Review, 19(1), 66.
Holthausen, R. (1981). Evidence on the effect of bond covenants and management compensation
contracts on the choice of accounting techniques
Jackson, S. (2008). The Effect of Firms ' Depreciation Method Choice on Managers ' Capital
Jackson, S., Liu, X., and Cecchini, M. (2009). Economic consequences of firms’ depreciation
method choice: Evidence from capital investments
Kieso, D., Weygandt, J. and Warfield, T. (2010). Intermediate Accounting (3rd ed.) . John Wiley
Khurana, I., and Loudder, M. (1994). The Economic Consequences of SFAS 106 in RateRegulated Enterprises. Accounting Review, 69(2), 364-381.
Lere, J. (1980). Optimal Depreciation Methods When Marginal Tax Rates Increase. Journal of
the American Taxation Association, 2(1), 9.
Livingstone, J. (1969). Accelerated Depreciation, Tax Allocation, and Cyclical Asset
Expenditures of Large Manufacturing Companies
Nikolai, L., Bazley, J. and Jones, J. (2010). Intermediate Accounting (11th ed.). Southwestern
Pratt, J. and Kulsrud, W (2005). Individual Taxation. ARC Publishing.
Reynolds, I. (1961). Selecting the proper depreciation method. Accounting Review, 36(2), 239.
Ricks, W. (1982) Market assessment of alternative accounting methods: a review of the
Schwab, B., and Nicol, R. (1969). From Double-Declining-Balance to Sum-of-the-Years '-Digits
Depreciation: An Optimum Switching Rule
Stice, E., Stice, J. and Skousen, K. F. (2008). Intermediate Accounting (17th ed.). Southwestern
Sunley Jr., E. (1971). An Optimum Switch from Double-Declining Balance to Sum-of-the-Years
Warren, C., Reeve, J. and Duchac, J. (2007). Accounting (22 ed.). Thomson: Southwestern
Weygandt, J., Kimmel, P. and Kieso, D. (2008). Financial Accounting (6th ed.). John Wiley and
Please join StudyMode to read the full document