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Reducing/Declining Balance Depreciation

Assignment / Homework Help
Reducing Balance Depreciation Method or Declining Balance Method

Under the declining balance method also known as reducing or diminishing balance or written down value method, a depreciation percentage rate is applied to the acquisition or construction cost at the beginning of the accounting period rather than the original cost. Under this system, a fixed percentage of the diminishing value of the asset is written off each year so as to reduce the asset to its break-up or scrap value at the end of its life. Under this method, the annual charge for depreciation decreases from year to year. The effect is that the initial years take a higher hit of depreciation charge as compared to the later years. Unlike the straight-line method where the cost of asset is completely written-off, this never happens in the reducing balance method. It must be noted that salvage value is not considered in the calculation of depreciation. However, the book value of the asset is never brought below its salvage value.


The rate of depreciation under this method may be determined by the following formula:


1 - nResidual Value   X 100
         Cost of Asset

n = number of years

Depreciation is charged at this rate on the original cost of the asset in the first year and on book value or written down value of the previous year from 2nd year onwards.

Advantages:
  • Simple to compute
  • It is a fair method as the total charge relating to the asset to revenue is uniform over the life of asset. In the initial period, the charge for depreciation will be higher and repairs lower. This trend reverses as the time passes when the depreciation charge would lower but repair expenses would rise.
Disadvantages:
  • A lower application of the percentage used for computing depreciation may be harmful to the enterprise leading to lower charge of depreciation and leading to under charge in the income statement. This may lead to the enterprise not setting aside enough resources to replace the asset at the end of its useful life.
Example:
John Bros. acquired a machine on 1st Jan 2009 at a cost of $14,000 and spent $1,000 on its installation. The firm writes off the depreciation at 20% every year. The salvage value of the machine is $5,000 at the end of 5 years. The books are closed on 31st December every year. Compute depreciation.

Book Value - Beginning of Year Depreciation Rate Depreciation Expense Accumulated Depreciation Book Value - End of Year
$15,000 (Original Cost) 20% $3,000 $3,000 $12,000
$12,000 20% $2,400 $5,600 $9,600
$9,600 20% $1,920 $7,520 $7,680
$7,680 20% $1,536 $9,056 $6,144
$6,144 $6,144 - $5,000 $1,144 $10,000 $5,000 (Scrap Value)


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