Double Declining Depreciation

The double-declining depreciation method is an accelerated depreciation method where the depreciation expense decreases with the age of the asset. The depreciation charge under the double declining depreciation method is calculated by applying the higher depreciation rate to the asset book value at the start of the period.

Though the straight-line method is the straightforward and popular method for calculating depreciation, there are some instances when it is not the appropriate method. The assets are most productive when they are new, and gradually their productivity declines due to normal wear and tear. Thus, the assets generate more revenue in their early years. Therefore, to get the true picture of the performance of the company through financial statements, it is required to match the expenses with revenues. The double-declining method achieves this as, under this method, more depreciation is charged in the early years and reduces in the subsequent years.

This method is also known as the 200% declining balance method of depreciation. Here, double means 200% of the straight-line depreciation rate.

Formula

To calculate depreciation by using the double-declining depreciation formula will be:

Double declining balance depreciation= 2*cost of asset*depreciation rate

Or

Double declining balance depreciation= 2* cost of the asset/ useful life of the asset

How to Calculate the Double Declining Balance Depreciation

To calculate the depreciation under this method, follow the following steps:

Step 1

Determine the asset opening book value and the residual value—also the remaining useful life of the asset.

Step 2

Calculate the straight-line depreciation rate

Straight line depreciation rate= cost -expected residual value/expected useful life of asset

Step 3

Determine the double-declining balance rate by multiplying the straight-line depreciation rate by 2

Double declining balance rate= 2* straight-line depreciation rate.

Step 4

Apply the derived rate (step2) to the book value of the asset at the start of each period

Double declining balance depreciation= double-declining balance rate * book value of the asset

Step 5

Repeat until the asset depreciates completely.

And you can also refer to Double Declining Depreciation Calculator

Double Declining Depreciation

Advantages and Disadvantages of Double Declining Depreciation Method

Advantages

Reduces Tax Obligation

In the initial years, the depreciation charge is higher than in the later years. so, by adopting this method, the business can save tax by lowering its tax liability

Matched Maintenance Cost

In the early years, higher depreciation is charged when the cost of repairs and maintenance is low. And in later years of asset life, low depreciation is charged when there is a higher cost of repairs and maintenance. This helps to make equality throughout the asset’s useful life.

Good Interest

A business generates interest when it invests the depreciation outside the business. Consequently, this helps to generate more funds to replace the asset.

The Minimum Loss at the Disposal

The business will have a minimum loss when the asset disposes of due to the innovation as a large part has already been changed into profit and loss account through depreciation.

Disadvantages

Depicts Poor Performance

The financial statements, when using this, shows the lower profit in the earlier years as the depreciation charge is higher in these years. This shows the poor performance of the business in the earlier years.

Low Dividend

The investors of the business will receive a low dividend as the business will generate lower profit in the initial years. As a result, investors will not be happy with the performance of the company.

More Complicated

The double-declining method is more complicated than the straight-line method. The calculations are to be done carefully to avoid any costly mistakes.

Value of Asset can Never be Zero

Under this method, the value of an asset can never reach zero.

Example

Assume a retailer purchases a fixture on February 1 costing $200000. There will be no residual value at the end of 10 years of useful life.  Calculate the depreciation using the double-declining depreciation method.

Solution

Calculating the depreciation through the double declining depreciation method

where,

The book value of the asset = $200000

Residual value= $0

The useful life of the asset = 10 years

Under the straight-line method, the useful life of  10 years means that the asset will depreciate at the rate of 10% of the cost of an asset. Therefore, under the double-declining method, the 10% straight-line depreciation rate is double to 20%. However, the 20% will be multiplied with the book value of the asset at the beginning of the period, not by the original cost of the fixtures.

Year 1

The book value of fixtures is $200000. Therefore, now multiply $200000 by 20%, and the result will be $40000, which will be depreciation for the first year. The journal entry will be

Depreciation A/c Dr.  $40000

To Accumulated depreciation A/c $40000

Year 2

The book value of fixtures at the beginning of the 2nd year is $160000, which is the cost of fixtures minus the accumulated depreciation of $40000 of year 1. Now multiply the $160000 with 20% the result is $32000, which is the depreciation for the second year.

Year 3

At the beginning of the third year, the book value of fixtures is $128000 (200000-40000-32000). Now by multiplying $128000 by 20%, the result is $25600, which will be the depreciation for the third year.

Year 4

The book value at the start of the 4th year will be $102400. By multiplying the book value of $102400 by 20%, the result of $20480 is the depreciation expense for year 4.

Year 5

At the start of the 5th year, the book value is $81920. Now multiply $81920 by 20%; the result of $16384 is the depreciation for the 5th year.

Year 6

At the start of the sixth year, the book value of the fixture is $65536. This amount has to depreciate over a period of 5 years. At this time, most companies switch to the straight-line depreciation method and debit depreciation expense and credit accumulated depreciation A/c by $13107 ($65536/5 years) in the remaining 5 years.



Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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