Live Support
+1-802-778-9005The Declining Balance Depreciation Method is an accelerated depreciation system that records larger depreciation expenses during the asset’s earlier years. Due to increased initial usage and maintenance costs, assets lose value more quickly in the early years.
It is also known as the “Reducing-Balance Method“.
Under this method, an asset undergoes depreciation at a constant rate, which is applied to its declining book value each year. This results in accelerated depreciation and higher values in the early years of the asset’s life.
The declining balance method’s highly versatile nature makes it useful when matching depreciation cost to an asset’s usage/productivity rate. Given the opportunity to offset a greater proportion of taxable income in the initial years, this could result in tax benefits.
Companies use this method for recording assets like computers, printers, cell phones, and other high-technology products that quickly become obsolete.
Declining Balance Depreciation = Current Book Value * Depreciation rate
where:
Current Book Value = Net Book Value – Residual Value
On April 1, 2011, Johnson Jenner Private Limited purchased equipment at the cost of $140,000.
The equipment is estimated to have a useful life of 5 years. At the end of the 5th year, its salvage value will be $20,000.
Johnson Jenner Private Limited recognizes depreciation to the nearest whole month. Using the 150 percent declining balance depreciation method, find the depreciation expenses for 2011, 2012, and 2013.
Solution:
Asset’s Useful Life = 5 years ( given)
Straight-line depreciation rate = 1/5
= 20% per year
So,
Depreciation rate (150 percent declining balance depreciation method) = 20% * 150%
= 20% * 1.5
= 30% per year
The depreciation amounts are calculated as follows:
Depreciation = $140,000 * 30% * 9/12
= $31,500
Depreciation = ($140,000 – $31,500) * 30% * 12/12
= $32,550
Depreciation = ($140,000 – $31,500 – $32,550) * 30% * 12/12
= $22,785
Depreciation = ($140,000 – $31,500 – $32,550 – $22,785) * 30% * 12/12
= $15,950
Depreciation = ($140,000 – $31,500 – $32,550 – $22,785 – $15,950 )*30% *12/12
= $11,165
Depreciation = ($140,000 – $31,500 – $32,550 – $22,785 – $15,950 -$11,165 )*30% *12/12
= $7,815
Note: In order to maintain the book value the same as the salvage value, the depreciation for the Year 2016 must be taken as $6,051 but not $7,815.
$26,051 – $20,000 = $6,051 (here, depreciation stops)
| Year | Book Value ( at the beginning) | Depreciation Rate | Depreciation Amount | Book Value ( at the end) |
| 2011 | $140,000 | 30% | $31,500 | $108,500 |
| 2012 | $108,500 | 30% | $32,550 | $75,950 |
| 2013 | $75,950 | 30% | $22,785 | $53,165 |
| 2014 | $53,165 | 30% | $15,950 | $37,216 |
| 2015 | $37,216 | 30% | $11,165 | $26,051 |
| 2016 | $26,051 | 30% | $6,051 | $20,000 |
To calculate the rate of depreciation for the Declining Balance Depreciation Method, the following formula is used:
Formula:
Declining Balance Depreciation Rate:
Rate of depreciation = (100% / Useful life of asset)
Double Declining Balance Depreciation Rate:
Rate of depreciation = 2 x (100% / Useful life of asset)
Important terms to consider:
Salvage Value: The value of the asset at the end of the useful life as estimated.
Cost of Asset: The price at which an individual or company acquires an asset; it may also measure the original value of a fixed asset.
Useful Life: The period in terms of years it is expected the asset will be in use.
The Fixed Declining Balance Depreciation Method uses the same depreciation rate for the asset throughout its useful life. This method leads to higher charge-off depreciation in the initial year and, subsequently, a smaller amount as the asset gets older. The depreciation is fixed at the beginning and is used to evenly distribute the cost of the asset over its useful life. Still, since the amount used to charge depreciation is based on the book value, the amount of depreciation charged will be reduced in future years. The formula used to calculate fixed declining balance depreciation in this method is:
Depreciation Expense = Depreciation Rate x Book Value at the Beginning of the Year
This means that all that is required to arrive at the Depreciation Expense is the multiplication of the depreciation rate and book value at the beginning of the year under consideration. This method is appropriate for assets that decline in value significantly in the first few years of use.
The Variable Declining Balance Method or the Double Declining Balance Depreciation Method is also an example of the accelerated depreciation method that grants derivation in the rate of depreciation up to twice the straight line. This method provided a quicker depreciation charge in the initial years of the assets and charges less after some years of the use of the asset. This is expressed as a proportion of the asset’s original book value; this leads to high depreciation expenses in the initial years while low expenses in the subsequent years. The formula to calculate the variable declining balance method is:
Depreciation Expense = 2 × (Straight-Line Depreciation Rate) × Balance of the asset account at the start of the year
This approach is particularly useful for business fixed assets, particularly technology or machinery, that experience significant depreciation in the first few years of their useful life.
The two widespread techniques of cost allocation are the Declining Balance Depreciation Method and the Straight-Line method, although the two are dissimilar regarding the depreciation rate and utilization.
The formula for the Depreciation charged in the Declining Balance Method is more in the early years and less in the later years. This is done by using a specific rate that is charged on the book value of the asset at the start of every year. In this case, book value, which is the net asset, is shared over the useful life; hence, when the book value reduces over time, depreciation also reduces. They are most appropriate for use where the assets have the higher proportion of their cost charged to expense during their earliest years of use, for instance, machinery or technology assets.
On the other hand, the Straight-Line Depreciation Method allocates the asset’s cost equally between the number of years in the useful life period. This tends to imply that the same proportion of the cost is charged as depreciation each year, which in turn is easier and more easily understandable. The straight-line method provides a perfect match of the assets that produce values that are similar throughout their useful life expectancy, such as buildings or office equipment. Despite more extensive initial deductions in the declining balance method, this method gives a coordinated expense over time, which may be more acceptable for accurate cost estimates and future prognoses.
Businesses must choose the appropriate depreciation method based on the asset, its planned use, and how technological advancements may affect its usefulness. The Declining Balance Depreciation Method works best with assets and equipment, like technological goods, that are likely to become outdated and worthless in a matter of years.
