Declining Balance Method of Depreciation
Declining balance method of depreciation is a technique of accelerated depreciation in which the amount of depreciation that is charged to an asset declines over time. In other words, more depreciation is charged during the beginning of the life time and less is charged during the end.
Why more depreciation is charged in beginning years? The reason is that assets are usually more productive when they are new and their productivity declines gradually. Thus, in the early years of their life time, assets generate more revenue as compared to the revenue generated in later years of their life. According to the matching principle of accounting, we should depreciate more of the asset's cost in early years to match the depreciation expense with the revenue earned from the use of the asset.
Formula and Calculation Procedure
Declining balance depreciation is calculated using the following formula:
|Depreciation = Depreciation Rate × Book Value of Asset|
Depreciation rate is given by the following formula:
|Depreciation Rate = Accelerator × Straight Line Rate|
In the above formula, accelerator is a multiplication factor which accelerates depreciation. Book value is the difference between cost of an asset and its accumulated depreciation. During the first accounting period, accumulated depreciation is zero so book value is equal to cost. Since the book value decreases after each depreciation charge, depreciation expense declines in successive charges.
Depreciation is charged according to the above method as long as book value is less than the salvage value of the asset. No more depreciation is provided when book value equals salvage value.
Double Declining Balance Depreciation Method
Double declining balance depreciation method is a type of declining balance depreciation method in which depreciation rate is double the straight-line depreciation rate. For straight-line depreciation rate of 8%, double declining balance rate will be 2 × 8% = 16%.
Example 1: An asset costing $20,000 has estimated useful life of 5 years and salvage value of $4,500. Calculate the depreciation for the first year of its life using double declining balance method.
Straight-line Depreciation Rate = 1 ÷ 5 = 0.2 = 20%
Declining Balance Rate = 2 × 20% = 40%
Depreciation = 40% × $20,000 = $8,000
Example 2: Referring to Example 1, calculate the depreciation of the asset for the second year of its life.
Declining Balance Rate = 40%
Book Value = Cost − Accumulated Depreciation = $20,000 − $8,000 = $12,000
Depreciation = 40% × $12,000 = $4,800
Example 3: Calculate the depreciation of the asset mentioned in the above examples for the 3rd year.
Declining Balance Rate = 40%
Book Value = $20,000 − $8,000 − $4,800 = $7,200
Depreciation = 40% × $7,200 = $2,880
The depreciation calculated above will decrease the book value of the asset below its estimated residual value ($7,200 − $2,880 = $4,320 < $4,500). Therefore depreciation would only be allowed up to the point where book value = salvage value. Thus,
Depreciation Allowed = $7,200 − $4,500 = $2,700
Written by Irfanullah Jan