Double Declining Balance Method is one of the accelerated methods used for the calculation of the depreciation amount to be charged in the income statement of the company and it is calculated by multiplying the Book value of asset with Rate of depreciation as per straight-line method and 2
Double Declining Balance Depreciation Method
A double-declining balance method is a form of an accelerated depreciation method in which the asset value is depreciated at twice the rate it is done in the straight-line method. Since the depreciation is done at a faster rate (twice to be precise) of the straight-line method, it is called accelerated depreciation.
However, accelerated depreciation does not mean that the depreciation expense will also be higher. The asset will depreciate by the same amount; however, it will be expensed higher in the early years of its useful life while the depreciation expense will be lower in the later years as compared to the straight-line method of depreciation.
Double Declining Balance Method Formula
Using the Double-declining balance method, the depreciation will be:
- Double Declining Balance Method Formula = 2 X Cost of the asset X Depreciation rate or
- Double Declining Balance Formula = 2 X Cost of the asset/Useful Life
How to Calculate Double Declining Balance Depreciation
The following are the steps involved in the calculation of depreciation expense using a Double declining method.
- Determine the initial cost of the asset at the time of purchasing.
- Determine the salvage value of the asset, i.e., the value at which the asset can be sold or disposed of after its useful life is over.
- Determine the useful or functional life of the asset
- Calculate depreciation rate, i.e., 1/useful life
- Multiply the beginning period book value by twice the depreciation rate to find the depreciation expense
- Deduct the depreciation expense from the beginning value to calculate the ending period value
- Repeat the above steps till the salvage value is reached
Double Declining Method Example
Suppose a business has bought a machine for $ 100,000. They have estimated the useful life of the machine to be 8 years with a salvage value of $ 11,000.
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Now, as per the straight-line method of depreciation:
- Cost of the asset = $ 100,000
- Salvage Value = $ 11,000
- The useful life of the asset = 8 years
- Depreciation rate = 1/useful life *100 = (1/8) * 100 = 12.5%
Double-declining balance formula = 2 X Cost of the asset X Depreciation rate.
Here, it will be 2 x 12.5% = 25%
- Year 1 Depreciation = $100000 X 25% = $25,000
- Year 2 Depreciation = $75,000 x 25% = $18,750
Depreciation account of the balance sheet will look like below over the 8 years of the machine’s life:
In the above table, it can be seen:
- In the double declining balance formula, depreciation rate remains the same and is applied to the ending value of the last year
- The double declining balance depreciation value keeps decreasing over the life of the asset
- The final double declining balance depreciation expense was $ 2348, which is less than the actual $3,338 (25% of $13,348 ). It was done to keep the salvage value as estimated
How to adjust the depreciation charges on the Balance sheet, Income statement, and the cash flow statement?
Now, we will look into how this expense is charged on the Balance sheet, income statement, and cash flow statement in detail. Let us take the double declining balance example of the machine:
- When the machine is bought for $ 100,000, the cash and cash equivalents are reduced by $ 100,000 and moved to the Property, plant, and equipment line of the balance sheet.
- At the same time, an outflow of $ 100,000 is shown in the cash flow statement.
- Now, $ 25,000 will be charged to the income statement as a depreciation expense in the first year, $ 18,750 in the second year, and so on for 8 continuous years. Although all the amount is paid for the machine at the time of purchase, however, the expense is charged over a period of time.
- Every year respective depreciation expense is added to a contra account of the balance sheet, i.e., Property, plant, and equipment. This is called accumulated depreciation. This is to reduce any carrying value of the asset. Thus, after the 1st year, the accumulated depreciation will be $ 25000. After 2nd year it will be $ 43,000, and so on, till the end of the 8th year, it will be $ 89,000.
- After the useful life of the machine is over, the carrying value of the asset will be only $ 11,000. The management will sell the asset, and if it is sold above the salvage value, a profit will be booked in the income statement or else a loss if sold below the salvage value. The amount earned after selling the asset will be shown as the cash inflow in the cash flow statement, and the same will be entered in the cash and cash equivalents line of the balance sheet.
When is the Double Declining Method used?
Double declining balance method is used in two circumstances:
- When the asset is utilized at a more rapid rate in the initial years of its useful life
- When the business intends to recognize the expense in the early stage to reduce profitability and thereby defer taxes
Disadvantages of Double Declining Method of Depreciation
The double-declining balance method has some disadvantages over the straight-line method:
- It is a bit complex than the more traditional and simpler straight-line method.
- Most of the assets are used consistently over their useful life, thus depreciating them at an accelerated rate does not make sense. Further, it does not reflect the actual use of the asset.
- A double-declining balance method skews profitability. The Company less profitable in the early years than in later years; thus, it will be difficult to measure the true operational profitability of the Company.
A double-declining balance depreciation method is an accelerated depreciation method that can be used to depreciate the value of the asset over the useful life of the asset. It is a bit complex method than the straight-line method of depreciation but is useful for deferring tax payments and maintain low profitability in the early years.
This has been a guide to the Double Declining Balance Method of Depreciation. Here we discuss its double declining balance formula along with practical examples, advantages, and disadvantages. You may learn more about accounting from the following article –