Declining Balance Method of Depreciation
Declining balance method of depreciation is an accelerated depreciation method in which the depreciation expense declines with age of the fixed asset. Depreciation expense under the declining balance is calculated by applying the depreciation rate to the book value of the asset at the start of the period.
While the straight-line depreciation method is straight-forward and most popular, there are instances in which it is not the most appropriate method. Assets are usually more productive when they are new, and their productivity declines gradually due to wear and tear and technological obsolescence. Thus, in the early years of their useful life, assets generate more revenues. For true and fair presentation of financial statements, matching principle requires us to match expenses with revenues. Declining-balance method achieves this by enabling us to charge more depreciation expense in earlier years and less in later years.
There are different variants of declining-balance method: 150%-declining balance method, 200%-declining balance method (also called double-declining balance method) and so on. The percentage is called accelerator and it reflects the degree of acceleration in depreciation. The basic formula for declining-balance depreciation (DBD) expense for a period is as follows:
|DBD = A ×||1||× (C - AD)|
Where DBD is the declining-balance depreciation expense for the period, A is the accelerator, C is the cost and AD is the accumulated depreciation.
Depreciation is charged according to the above method if book value is less than the salvage value of the asset. No more depreciation is provided when book value equals salvage value.
The declining-balance depreciation in which the depreciation rate is double (i.e. 200%) the straight-line depreciation rate is called double-declining depreciation. For straight-line depreciation rate of 8%, double declining balance rate will be 2 × 8% = 16%.
Following steps highlight all the intermediate calculations needed to arrive at the depreciation expense under the declining-balance method:
STEP 1: Identify the asset's opening book value and its remaining useful life.
STEP 2: Calculate the straight-line depreciation rate.
|Straight-Line Rate =||1|
STEP 3: Identify the acceleration percentage and multiply it with the straight-line depreciation rate to work out the declining-balance depreciation rate.
|Declining-balance Depreciation Rate = Accelerator × Straight Line Rate|
STEP 4: Apply the declining balance depreciation rate to the opening book value of the asset to calculate the depreciation expense for the period.
|Declining-balance Depreciation Expense = Declining-balance Depreciation Rate × Opening Book Value|
|Declining-balance Depreciation Expense = Declining-balance Depreciation Rate × (Cost- Accumulated Depreciation)|
STEP 5: Subtract the depreciation expense from the opening book value of the asset and check that it is not less than the salvage value. If the closing book value is more than the salvage value, the depreciation expense worked out in Step 4 is the declining-balance depreciation expense for the period. However, if the book value drops below salvage value, calculate depreciation expense as the difference between opening book value and salvage value.
Example 1: Double-Declining Depreciation in First Period
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
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: Double-Declining Depreciation in Last Period
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 expense of $2,700 (= $7,200 − $4,500) is allowed.
by Irfanullah Jan, ACCA and last modified on