Before we discuss Double Declining Balance method, lets have a review of basic Declining Balance method and understand how it works.
Declining balance method: a type of accelerated depreciation method
Declining Balance method or reducing balance method or diminishing balance method is basically one type of accelerated depreciation method which accelerates the recognition of depreciation expense and thus more depreciation is recorded in the earlier years of useful life of the asset and comparatively lesser expense is recognised in the last years of useful life. This method corresponds to the thought that as the productivity of the asset is at the peak in the starting years and decreases with the passage of time that is why the depreciation expense for the starting years should be high and then reduces inline with the declining productivity.
Declining balance method vs Straight-line method
Contrary to straight-line method in which a constant rate of depreciation is applied to the depreciable value which also remains constant (unless estimates of residual value change) and thus gives a constant depreciation expense figure every accounting period, under reducing balance method a constant rate of depreciation is applied to the remaining carrying value (net book value) which reduces with the recognition of depreciation expense every accounting period that is why this method is known as declining balance method as the depreciation rate is applied on net book value which is the remaining undepreciated balance of the asset that reduces every year.
Mechanism of declining balance method
The application of declining balance method of depreciation is a two-step process as follows:
Step 1: Determining the depreciation rate
The first step is to determine the rate at which asset will be depreciated which can be computer using the formula given below.
D = depreciation rate
n = number of useful years
r = residual value or scrap value
c = cost of the asset
As the rate itself is constant and does not change that is why it is also called straight-line rate. Another reason why this rate is called straight-line rate is that even under straight-line method rate might be the same but only the way it is applied under the two methods is different. However, mostly the depreciation rate under straight-line method and reducing balance method is very different keeping the useful life and residual value the same.
Step 2: Determining the acceleration factor
The second step involves the determination of acceleration factor that corresponds the pace at which economic benefits are extracted from the asset due its use in the business. The acceleration factor is kind of a “weight” that adjusts the depreciation rate to correspond with the consumption pattern.
The acceleration factor is mostly expressed in terms of percentage but often in terms of times. The acceleration factor can be 100% (1 time) or 150% (1.5 times) or 200% (2 times).
Mostly the acceleration factor is 100% but it can be different according to the situation. For example the depreciation rate is 10% then for 100% acceleration factor the applicable rate will also be 10% but for 200% acceleration factor even though the depreciation rate is 10% the applicable rate will be 2 x 10% = 20%.
Double Declining balance method
Now we can easily understand that Double Declining balance method of depreciation is such declining balance method in which the acceleration factor is 2 or 200%.
Double declining balance method and IASs
According to International Accounting Standard (IAS) 16 para 60:
The depreciation method used shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity.
Therefore, if the depreciation calculated according to this method reflects the consumption pattern of the assets economic benefits then it can be used by the entity even if this method is not named under IASs. IASs do not restrict the entity to use any particular method for depreciation purposes. However, entity may be under an obligation to use a particular method for taxation purposes under taxation laws but for accounting purposes under IASs entity is not under an obligation to use any particular depreciation method. But as said above the method selected should reflect the consumption pattern of benefits.
ABC Co. bought an asset with a cost of 200,000 and scrap value of 15,000.
Required: Calculate the depreciation expense for first three years if the depreciation method is:
- straight-line method with 10% rate
- reducing balance method and the rate is 10% with an acceleration factor of:
Year 1 = 200,000 – 15,000 = 185,000 x 10% = 18,500
Year 2 and year 3: same as year 1
Reducing balance method
Acceleration factor 100% i.e. 10% x 1 = 10%
Year 1 = 200,000 – 0 = 200,000 x 10% = 20,000
Year 2 = 200,000 – 20,000 = 180,000 x 10% = 18,000
Year 3 = 200,000 – 38,000 = 162,000 x 10% = 16,200
Acceleration factor 150% i.e. 10% x 1.5 = 15%
Year 1 = 200,000 – 0 = 200,000 x 15% = 30,000
Year 2 = 200,000 – 30,000 = 170,000 x 15% = 25,500
Year 3 = 200,000 – 55,500 = 144,500 x 15% = 21,675
Acceleration factor 200% i.e. 10% x 2 = 20%
Year 1 = 200,000 – 0 = 200,000 x 20% = 40,000
Year 2 = 200,000 – 40,000 = 160,000 x 20% = 32,000
Year 3 = 200,000 – 72,000 = 128,000 x 20% = 25,600