Reducing / Declining Balance Depreciation Homework Help & Tutoring
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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 - n√Residual Value X 100
Cost of Asset
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.
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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