Declining Balance Method of Assets Depreciation
What Is the Declining Balance Method of Assets Depreciation? – Definition
Under the declining balance method, depreciation is charged on the book value of the asset, and the amount of depreciation goes on decreasing every year.
An accelerated method of assets depreciation in which the asset’s book value at the beginning of each ledger is multiplied by a constant percentage.
As alternative systematic allocation schemes, several declining balance methods of computing depreciation expenses have been developed. They determine the annual charge by multiplying a percentage rate by the book value of the asset (not the depreciable basis) at the beginning of the year. Because the book value declines as the asset gets older and the rate stays constant, the depreciation charge gets smaller each year.
Financial accounting applications of declining balance are often linked to income tax regulations which allow the taxpayer to compute the annual rate by applying a percentage multiplier to the straight-line rate. According to the type of property, the multiplier assumes a value such as 1.25, 1.50, or 2.00 (when the multiplier is 2.00, the method is known as double declining). The applied rates for several situations are shown below:
Under the declining-balance methods, the asset’s salvage value is used as the minimum book value; the total lifetime depreciation is thus the same as under the other methods. The arbitrary rates used under the tax regulations often result in assigning depreciation to more or fewer years than the service life.
Under the declining-balance method, yearly depreciation is calculated by applying a fixed percentage rate to an asset’s remaining book value at the beginning of each year. Because twice the straight-line rate is generally used, this method is often referred to as double-declining balance depreciation.
For example, the equipment has a five-year life. This results in an annual straight-line percentage rate of 20% (1 / 5 = 20%). The double-declining-balance rate is 40% (2 x 20%). This rate is applied to the asset’s remaining book value at the beginning of each year. When applying the double-declining-balance method, the asset’s residual value initially is not subtracted from the asset’s acquisition cost to arrive at a depreciable cost, as it is when applying the straight-line method, the unit-of-production method, and the sum-of-the-years-digits method.
Residual value is considered only in the last year of the asset’s life, when that year’s depreciation is limited to the amount that will reduce the asset’s book value to its residual value. These points are illustrated in the following schedule, which computes yearly depreciation for the equipment:
* Depreciation expense in 2019 is the amount required to reduce the equipment’s book value to its residual value of $4,000 ($5,184 – $4,000 = $1,184).
Partial-year depreciation also can be calculated by using the declining-balance method. For example, if the equipment in the above illustration is purchased on October 1 rather than On January 2, depreciation for the period between October 1 and December 31 is ($16,000 x 3/12). In the second year, depreciation is calculated in a regular manner by multiplying the remaining book value of $36,000 ($40,000 — $4,000) by 40%.
In the above example, we assumed a depreciation rate equal to twice the straight-line rate. However, many firms use a rate equal to one and one-half the straight-line rate. That is called 150% declining-balance depreciation and is calculated in the same manner as is double-declining-balance depreciation, except that the rate is 150% of the straight-line rate.
Advantages of the Declining Balance Method
(i) Equal Burden. The method puts a burden for use of the asset on each subsequent year. The amount of depreciation goes on decreasing for each subsequent year while the charge for repairs goes on increasing for each subsequent year. Thus, an increase in the cost of repairs of each subsequent year is compensated by a decrease in the amount of depreciation for each subsequent year.
(ii) Simple Method. The method is simple to understand and easy to follow.
(iii) Suitable to Tax Authorities. This method is recognized by the Income Tax authorities.
Disadvantages of Declining Balance Method
(i) No Zero Value. The value of the asset cannot be brought down to zero under his method.
(ii) Rate Determination is not easy. The determination of a suitable rate of depreciation is also different under this method as compared to the Fixed Instalment method.
First of all, under the declining balance method, we need to calculate the depreciation rate using the straight-line method of depreciation via the following formula:
Straight-line depreciation rate = 1/asset’s useful life
Now we need to calculate accelerated depreciation rate using the declining balance method through the following formula:
Accelerated depreciation rate = straight-line depreciation rate × Specific percentage
Now the final step is to calculate the depreciation expense using the following formula:
Depreciation expense = Remaining book value × Accelerated depreciation rate
The following examples show the application of double and 150 percent declining-balance methods to calculate the asset’s depreciation:
Asset’s details are as below:
Note that the double-declining multiplier resulted in depreciation expense for only four years and that the expense in the fourth year was limited to the amount needed to reduce book value to the $20,000 salvage value. For the 150 percent declining-balance application, the depreciation is taken over six years, with the amount in the sixth year being limited to the amount needed to produce the $20,000 book value.
Double declining balance depreciation
150 percent declining balance depreciation
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.