What is the Retirement Method of Depreciation?

The retirement method of depreciation involves waiting until a fixed asset is retired from service before charging its cost to depreciation. When depreciation is eventually recognized, the amount is net of any salvage value of the asset. The method was once used by public utilities and railroads, but the practice has fallen into disuse. The justification for this method was that it reduced the amount of accounting effort associated with smaller-value assets.

Problems with the Retirement Method

There are several problems with the retirement method, which are as follows:

No periodic depreciation charge. This method does not allocate depreciation expenses annually, which can lead to inconsistent accounting records and financial statements.
Inaccurate financial reporting. Since expenses are not matched with the revenues generated by the asset over its useful life, financial statements may not reflect the true cost of operations in each accounting period.
Incorrect performance metrics. Any financial performance metrics calculated for the business will be incorrect, since expenses are being artificially deferred.
Potential for large expense at retirement. When an asset is retired, the full cost is expensed at once, leading to a sudden and significant impact on the income statement, which may distort the financial results of that year.
Not GAAP compliant. This method does not conform to the matching principle under Generally Accepted Accounting Principles (GAAP), which requires expenses to be recognized in the same period as the revenues they help generate.
Tax implications. Tax authorities typically require periodic depreciation to calculate taxable income. Using the retirement method may lead to non-compliance with tax regulations.

While the retirement method may be useful in certain industries (e.g., public utilities) or for specific assets that are not frequently replaced, its drawbacks—such as non-compliance with standard accounting principles and the distortion of financial results—make it unsuitable for most businesses.