Declining Balance Method of Depreciation

What is the Declining Balance Method of Depreciation?

The declining balance method of depreciation, also known as the reducing balance method of depreciation, is a method in which depreciation calculated on the asset is deducted from the book value of the asset at the beginning of the year, the value of which is arrived at by multiplying the depreciation rate to the book value of the asset which has a greater amount in initial years and goes on declining with each passing year.

Explanation of the Declining Balance Method of Depreciation

Under the declining balance method of depreciation, depreciation is calculated in the following manner:

• Step1: Determine the book value of the asset at the beginning of the year.
• Step 2: Ascertain the depreciation rate.
• Step 3: Multiply the book value of the asset at the beginning of the year with the depreciation rate. If the asset was purchased in the middle of the year, then a pro-rata rate of depreciation will be applied.
• Step 4: Deduct the depreciation amount calculated in Step 3 from the book value of the asset determined at the beginning of the year in Step 1. We arrive at the written down value of the asset at the end of the year through this.
• Step 5: Repeat Step 1 to Step 4 again for the next year and so on until the asset’s value becomes nil.

Depreciation = Book value of the asset at the beginning of the year × Depreciation rate× Number of days the asset is used during the year/365

Written down value = Book value of the asset at the beginning of the year – Depreciation

Examples of Declining Balance Method of Depreciation

Following are the examples are given below:

Example #1

Let us consider an example where a machine was purchased by Company A for $200 on 1^st January 2020 for use in the production of its goods. Calculate depreciation for each year with respect to the machine. Assume the depreciation rate to be 35%.

• First, we ascertain the book value of the machine at the beginning of the year.
• Second, we multiply the book value at the beginning of the year with the depreciation rate.
• Third, we deduct depreciation from the book value at the beginning of the year.

The calculations are shown below:

Example #2

Now let us take an example where equipment was purchased by Company B on 30^th June 2020 for $300 and the depreciation rate to be charged on this asset is 40%. Calculate depreciation on equipment for each year. Assume 360 days in a year.

• First, we ascertain the book value of the machine at the beginning of the year.
• Second, we multiply the book value at the beginning of the year with the depreciation rate. Since the machine is purchased on 30^th June 2020, it can be said that it has been used for 6 months. Therefore, we will calculate the prorate depreciation.
• Third, we deduct depreciation from the book value at the beginning of the year.
• Fourth, we will calculate depreciation for the whole year for the subsequent years.

The calculations are shown below:

Example #3

Consider another example in which furniture is purchased for $500 on 1^st October 2020. Assume the depreciation rate to be 25%. Calculate depreciation for 10 years on this asset along with the book value at the end of each year. Assume 360 days in a year.

• First, we ascertain the book value of the machine at the beginning of the year.
• Second, we multiply the book value at the beginning of the year with the depreciation rate. Since the machine is purchased on 30^th June 2020, it can be said that it has been used for 3 months. Therefore, we will calculate the prorate depreciation.
• Third, we deduct depreciation from the book value at the beginning of the year.
• Fourth, we will calculate depreciation for the whole year for the subsequent years.

The calculations are shown below:

Importance of Declining Balance Method of Depreciation

Under the declining method of depreciation, a greater amount of depreciation is charged in the initial years of the life of the asset. This is a rational approach because the asset’s efficiency is higher in the initial years, and as the life of the asset goes on increasing, efficiency reduces. Thus, it can be said that this method of charging depreciation is the most appropriate one and is used widely too.

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Advantages of Declining Balance Method of Depreciation

A major advantage of the declining balance method of depreciation is that it matches the costs of the asset to the revenue it generates. A higher amount of depreciation is charged in the initial year when the asset is more productive. On the other hand, a lower amount is charged in the later years of the life of the asset.

Further, it balances the income statement as in later years, the costs of repair and maintenance increase and depreciation amount decreases. This shows a fair picture of the net income being reported.

Disadvantages of Declining Balance Method of Depreciation

Applying the declining balance method of depreciation can prove cumbersome due to the complex mathematical calculations involved. Moreover, sometimes it is not justifiable to charge different amount of depreciation in various years as it may not depict a true and fair position.

Conclusion

The declining balance method of depreciation, though complex, is used widely in organizations for computing depreciation to be charged on fixed assets. It is a popular tool to determine the quantum of benefits an asset can fetch throughout its useful life. Though there are various methods available for calculating depreciation, it is arguably the best way to compute the depreciation and remaining book value for each year.

Recommended Articles

This is a guide to the Declining Balance Method of Depreciation. Here we also discuss the introduction and example of the declining balance method of depreciation along with advantages and disadvantages. You may also have a look at the following articles to learn more –

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3. Dividend Declared
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