5. Derogatory Depreciation
The French derogatory depreciation ('amortissement d�rogatoire') is often used for large investments. Derogatory depreciation is the difference between two depreciation methods, a fiscal depreciation and an economic, that are applied to the same fixed asset.
The method for economic depreciation represents the 'actual' asset consumption. The economic depreciation in this case is an accelerated depreciation, meaning that the value of the fixed asset is reduced at a higher rate in the early years. Normally the method for declining balance depreciation is used for this purpose, or linear depreciation with a shorter lifetime. For the fiscal depreciation, which is used for tax reporting, linear depreciation is usually applied.
The depreciation amount at the end of each year is equal to the fiscal depreciation plus the derogatory depreciation. This encourages companies to invest in new equipment because of tax advantages.
The derogatory depreciation is posted to a reserve account. Since the depreciation will be negative during the latter part of the lifetime, the reserve is gradually reversed. Thus, the total of the derogatory depreciation during the entire lifetime of the asset is always equal to zero.
In the standard scenario where the derogatory depreciation is based on a combination of declining balance depreciation and linear depreciation, the derogatory depreciation will start on the acquisition date. (Declining balance depreciation is based on the acquisition date, whereas linear depreciation is based on activation date.)
5.1 Derogatory Depreciation in M3
In M3, two depreciation types are used in combination to calculate the derogatory depreciation at fixed asset type level. The economic depreciation is represented by the derogatory depreciation type, as mentioned above usually a depreciation type for declining balance depreciation. This depreciation type always has an ID within the range of 90–99. The fiscal depreciation is represented by the so-called associated depreciation type, usually reserved for linear depreciation.
The difference – the derogatory depreciation – is calculated automatically and displayed in the depreciation plan for the derogatory depreciation type.
For a description of how to migrate to derogatory depreciation, see Transferring to Derogatory Depreciation and Examples of Transfer to Derogatory Depreciation.
5.2 Example
An asset has been purchased for USD 120,000 and it is depreciated over 10 years. The table below shows the difference in depreciation when using the declining balance method compared to the linear method (declining depreciation amount – linear depreciation amount=derogatory).
| Year | Declining Depreciation (30%) | Declining Depreciation (30%) | Difference (Declining Depr. – Linear Depr.)=Derogatory |
|---|---|---|---|
| 1 | 36,000 | 12,000 | +24,000 |
| 2 | 25,200 | 12,000 | +12,500 |
| 3 | 17,640 | 12,000 | +5,640 |
| 4 | 12,340 | 12,000 | +340 |
| 5 | 8,646 | 12,000 | –3,354 |
| 6 | 6,052 | 12,000 | –5,948 |
| Etc. |
After ten years a final depreciation can be done for the residual value. See the information on residual value in the description of the declining balance depreciation.