What Is the Declining Balance Method?
The declining balance method is an accelerated depreciation system of recording larger depreciation expenses during the earlier years of an asset’s useful life and recording smaller depreciation expenses during the asset’s later years.
- In accounting, the declining balance method is an accelerated depreciation system of recording larger depreciation expenses during the earlier years of an asset’s useful life while recording smaller depreciation during its later years.
- This technique is useful for recording the depreciation of computers, cell phones, and other high-technology products that rapidly become obsolete.
- The declining balance technique represents the opposite of the straight-line depreciation method, which is more suitable for assets whose book value steadily drops over time.
How to Calculate Declining Balance Depreciation
Depreciation under the declining balance method is calculated with the following formula:
Declining Balance Depreciation=CBV×DRwhere:CBV=current book valueDR=depreciation rate (%)
Current book value is the asset’s net value at the start of an accounting period, calculated by deducting the accumulated depreciation from the cost of the fixed asset. Residual value is the estimated salvage value at the end of the useful life of the asset. And the rate of depreciation is defined according to the estimated pattern of an asset’s use over its useful life. For example, if an asset costing $1,000, with a salvage value of $100 and a 10-year life depreciates at 30% each year, then the expense is $270 in the first year, $189 in the second year, $132 in the third year, and so on.
What Does the Declining Balance Method Tell You?
The declining balance method, also known as the reducing balance method, is ideal for assets that quickly lose their values or inevitably become obsolete. This is classically true with computer equipment, cell phones, and other high-tech items, which are generally useful earlier on but become less so as newer models are brought to market. An accelerated method of depreciation ultimately factors in the phase-out of these assets.
The declining balance technique represents the opposite of the straight-line depreciation method, which is more suitable for assets whose book value drops at a steady rate throughout their useful lives. This method simply subtracts the salvage value from the cost of the asset, which is then divided by the useful life of the asset. So, if a company shells out $15,000 for a truck with a $5,000 salvage value and a useful life of five years, the annual straight-line depreciation expense equals $2,000 ($15,000 minus $5,000 divided by five).
Declining Depreciation vs. the Double-Declining Method
If a company often recognizes large gains on sales of its assets, this may signal that it’s using accelerated depreciation methods, such as the double-declining balance depreciation method. Net income will be lower for many years, but because book value ends up being lower than market value, this ultimately leads to a bigger gain when the asset is sold. If this asset is still valuable, its sale could portray a misleading picture of the company’s underlying health.
Employing the accelerated depreciation technique means there will be smaller taxable income in the earlier years of an asset’s life.
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