Accelerated Depreciation and Investment Decisions by Managers

Accelerated Depreciation and Investment Decisions by Managers

🔥 The article Economic consequences of firms’ depreciation method choice: Evidence from capital investments investigates how the way of accounting depreciation is affecting managers’ capital investment decisions. The authors find that accelerated depreciation is related to high levels of capital investments of managers, because of the lower book value that results from accelerated depreciation. Four particular reasons for this effect are mentioned in this article:

1. It might be possible that the book value of an asset affects the perceived utility managers will bring in the future. Assets with higher book values are perceived to deliver a higher future utility, as a result that these assets’ replacement will be impeded.
2. If an asset has a high book value, managers are likely to suppose that replacing the asset is wasteful behavior in that case. For example, not fully utilizing a purchased asset is seen as unpleasant; consumers can even overuse a product so that they at least get their money’s worth out of the product. If this is the case, than low book values encourage replacement and high book values will slow down replacement.
3. If financial statement losses on replacement are expected to be high, managers often decide to keep using existing assets instead of investing in new capital. In comparison with straight-line depreciated assets, assets depreciated under accelerated depreciation are less likely to result in losses on replacement (on the financial statement).
4. Finally, the financial statement effects on replacement are often more positive when assets are depreciated under accelerated depreciation in comparison to assets depreciated under straight-line depreciation. Since there is an increase in evidence that managers’ investment decisions are influenced by earnings (according to the authors), these positive financial statement effects should more often result in a higher level of capital investment.

Despite the above reasons why accelerated depreciated is likely to be related to high capital investment levels, the authors also mention one reason why accelerated depreciation can result in lower capital investment levels. This reason is that companies using accelerating depreciation will find higher increments to depreciation expenses in comparison to straight-line depreciated assets. So due to earnings considerations, managers using accelerated depreciation might decide not to invest in new capital.

Source: Jackson, S.B., Liu, X. and M. Cecchini. “Economic consequences of firms’ depreciation method choice: Evidence from capital investments. “ Journal of Accounting and Economics, Volume 48, Issue 1, October 2009, Pages 54–68