Declining Balance Depreciation: Formula, Example, Merits and Demerit

What is the Declining Balance Depreciation Method?

The 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, resulting in accelerated depreciation and higher values in the early years of the asset’s life.

Companies use this method for recording assets like computers, printers, cell phones, and other high-technology products that quickly become obsolete.

How do you calculate the Declining Balance Depreciation Method?

Formula of Declining Balance Depreciation Method

Declining Balance Depreciation = Current Book Value * Depreciation rate 

where:

• Current Book Value: It refers to the net value at the beginning of an accounting period.

Current Book Value = Net Book Value – Residual Value

• Residual value: It refers to the estimated salvage value at the end of the useful life of the asset.

• Depreciation Rate: It is determined based on the expected pattern of an asset’s usage over its useful life.

Steps to Calculate the Declining Balance Depreciation Method

Step 1: Calculate the asset’s beginning book value. It is determined by subtracting the accumulated depreciation from the cost of the fixed asset.

Step 2: Then, determine the asset’s useful life and its salvage value.

Step 3: Subtract the estimated salvage value from the cost of the asset to find the total depreciable amount.

Step 4: Next, determine the annual depreciation expense by multiplying the asset’s book value by the depreciation rate.

Step 5: Finally, subtract Depreciation Expense from Book Value and get the new book value.

Example of Declining Balance Depreciation Method

On April 1, 2011, Johnson Jenner Private Limited purchased equipment at the cost of $140,000.

The equipment is estimated to have a 5-year useful life. At the end of the 5th year, the salvage value will be $20,000.

Johnson Jenner Private Limited recognizes depreciation to the nearest whole month. Find the depreciation expenses for 2011, 2012, and 2013 using the 150 percent declining balance depreciation method.

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:

• For the Year 2011:

Depreciation = $140,000 * 30% * 9/12 

          = $31,500

• For the Year 2012:

Depreciation = ($140,000 – $31,500) * 30% * 12/12 

                     = $32,550 

• For the Year 2013:

Depreciation = ($140,000 – $31,500 – $32,550) * 30% * 12/12 

                     = $22,785

• For the Year 2014:

Depreciation = ($140,000 – $31,500 – $32,550 – $22,785) * 30% * 12/12 

                     = $15,950

• For the Year 2015:

Depreciation = ($140,000 – $31,500 – $32,550 – $22,785 – $15,950 )*30% *12/12 

                     = $11,165

• For the Year 2016:

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

Merits of Declining Balance Depreciation Method

• Benefits to the Tax System: Early depreciation costs lower taxable income, which may save taxes.

• Improvement in Cash Flow: Early tax savings can improve cash flow, supporting debt reduction or business reinvestment.

• Asset Replacement: Timely asset replacement planning can be facilitated by faster depreciation, which can yield more insightful data.

• Financial Reporting: It provides a more accurate picture of how an asset’s value and utility deteriorate over time.

Demerits of Declining Balance Depreciation Method

• Complex Calculations: Compared to straight-line depreciation, this approach necessitates more complicated calculations.

• Reduced Depreciation in Subsequent Years: Depreciation expense decreases dramatically with the asset’s useful life, which may cause it to fall out of step with rising maintenance and operating costs.

• Not Suitable for All Assets: This strategy is less suitable for assets that do not decline significantly in the first years of their life.

• Possibility of Financial Statement Fraud: Lower reported earnings in the early years due to high depreciation charges may not be a true reflection of the financial health of the company.

• Inconsistency with Non-Tangible Assets: This approach is less appropriate for assets like software or intellectual property that do not lose value quickly or have a long useful life.

Conclusion

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.