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Declining-Balance (DB) Methods (Depreciation Methods) - Noncurrent Assets
Declining-balance (DB) methods also result in accelerated depreciation charges. Annual depreciation expense is calculated by multiplying an asset’s book value (cost minus accumulated depreciation) at the beginning of the year by a percentage. The percentage equals a multiple of the straight-line rate. Frequently used multiples are 200% and 150%. Residual values are not used in the initial determination of declining-balance depreciation rates or depreciation expense.
Because the asset in our illustration has a five-year life, the straight-line rate is 20% (1/5 = 20%). Using a multiple of 200% (200% = 2.0) results in a declining-balance rate of 40% (20% X 2.0). A multiple of 200% is referred to as the double-declining-balance method (DDB). Depreciation charges for the first two years are $1,960 and $1,176, respectively:
Depreciation expense year 1 = (Cost - Accumulated Depreciation) X .4
= ($4,900 - $0) X .4
= $1,960
Depreciation expense year 2 = (Cost - Accumulated Depreciation) X .4
= ($4,900 - $1,960) X .4
= $1,176
A depreciation schedule for the five years is:
To be sure that you understand declining-balance depreciation, verify the calculation of year 3’s depreciation expense of $706.
Depreciation expense in the fifth year is not calculated in the typical way. The conventional calculation multiplies the book value at the end of year 4 ($635) by 40%. This yields an expense of $254. However, that expense would result in total accumulated depreciation of $4,519 ($4,265 + $254) and a book value of $381. Because an asset should not be depreciated to an amount below its residual value, depreciation in year 5 is limited to $235 (the amount that would leave a book value of $400).
Residual value is not utilized in the original determination of declining-balance depreciation because the computations themselves include an implicit residual value. By setting depreciation expense equal to a percentage of book value, a book value will always remain. Thus, there is no need to consider residual value explicitly until the end of an asset’s depreciation schedule; residual value must then be considered so that an asset’s book value is not depreciated below its residual value.
Figure 6.1 summarizes the results of the three depreciation methods discussed in this section.
Figure 6.1 - Summary of Depreciation Methods
*Assets should not be depreciated below their residual value.
NOTE: Total depreciation expense over the five years combined is the same under all methods. The methods differ only in the timing of depreciation charges. Also note that because total depreciation expense is the same across the five years, total net income over the five years will also be the same.
Depreciation Methods and Topics
- Straight-Line Method (Depreciation Methods)
- Sum-of-the-Years’-Digits Method (Depreciation Methods)
- Declining-Balance (DB) Methods (Depreciation Methods)
- Tax Depreciation
- Selection of Depreciation Method
- Misconceptions About Depreciation
Property, Plant, and Equipment (PPE) Topics
- Property, Plant and Equipment (PPE)
- Initial Valuation of Property, plant, and equipment (PPE)
- Depreciation of Property, plant, and equipment (PPE)
- Expenditures After Acquisition - Property, plant, and equipment (PPE)
- Disposals of Property, plant, and equipment (PPE)
- Write-Downs - Property, plant, and equipment (PPE)
- Financial Statement Presentation of Property, plant, and equipment (PPE)
- Utilization of Property, plant, and equipment (PPE)
- Percentage of PPE Depreciated (Age)
- Evaluation of the Accounting for Property, Plant, and Equipment (PPE)
Related Noncurrent Assets Topics
