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Declining Balance Depreciation

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Moneyzine Editor
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January 15th, 2024
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Declining Balance Depreciation

Definition

The term declining balance depreciation refers to one of several methods of allocating the cost of an asset over its expected lifetime. The declining balance depreciation method is an accelerated approach to depreciation, and is based on the assumption an asset's value declines at a greater rate in the early years of its serviceable life.

Calculation

Declining Balance Depreciation (%) = 2 / Serviceable Life of Asset

Explanation

Also known as the double-declining balance and reducing balance method, the declining balance approach to depreciation is an accelerated method, since it results in higher depreciation values in the early years of the asset's life relative to the straight line method. This approach is based on the assumption an asset provides greater value when it is newer.

The declining balance method does not take into consideration the salvage value of the asset when calculating the annual depreciation expense. However, the book value of the asset can never be lower than its salvage value. Adjustments need to be made to the final year of depreciation to prevent the book value from falling below the asset's salvage value.

Depreciation is an accounting method of cost allocation. It is used to allocate the cost of an asset over its useful life. Depreciation allows the cost of a balance sheet item (an asset) to flow smoothly to the income statement (as an expense) over its serviceable life.

Example

Company A purchases a backup generator for $200,000. The service life of the generator is expected to be 10 years. The generator is estimated to have a scrap value of $50,000 at the end of its serviceable life. The declining balance depreciation rate would be:

= 2 / 10 or 20% per year

In the first year of operation, the depreciation expense for this generator would be:

= 20% x $200,000 = 0.2 x $200,000, or $40,000

A complete declining balance depreciation schedule for the asset is shown below:

Depreciation Expense

Accumulated Depreciation

Book Value

Year 0

$200,000

Year 1

$40,000

$40,000

$160,000

Year 2

$32,000

$72,000

$128,000

Year 3

$25,600

$97,600

$102,400

Year 4

$20,480

$118,080

$81,920

Year 5

$16,384

$134,464

$65,536

Year 6

$13,107

$147,571

$52,429

Year 7

$2,429

$150,000

$50,000

Note that in Year 7, the depreciation expense is capped at $2,429 to prevent the book value of the generator from falling below the scrap value of the asset ($50,000).

Related Terms

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  • Depreciation
    The financial accounting term depreciation is sometimes defined as a decline in tangible plant's service potential. Depreciation is a method of allocating the cost of a tangible asset in a systematic manner to those time periods that benefit from the use of the asset.
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  • The financial accounting term straight line depreciation refers to one of several methods of allocating the cost of an asset over its expected lifetime. The straight line depreciation method is based on the assumption the asset will lose the same value each accounting period.
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  • The term units-of-output depreciation refers to one of several methods of allocating the cost of an asset over its expected lifetime. The units-of-output depreciation method is based on the assumption the asset will output a fixed number of units over its lifetime; therefore, the depreciation expense in a given accounting period is directly related to the asset's output in that same accounting period.
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  • The financial accounting term sum of the years' digits depreciation refers to one of several methods of allocating the cost of an asset over its expected lifetime. The sum of the years' digits approach is an accelerated method of depreciation and is based on the assumption an asset's value declines at a greater rate in the early years of its serviceable life.
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  • Modified Accelerated Cost Recovery System (MACRS)
    The finance term Modified Accelerated Cost Recovery System, or MACRS, refers to the tax depreciation structure created as a result of the Tax Reform Act of 1986. MACRS is an accelerated approach to the depreciation of an asset, and is based on both the declining balance and straight line methods.
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  • Depreciable Base
    The financial accounting term depreciable base is used to describe the value that is divided by the service life of the asset to determine the annual depreciation expense under the straight line method. The depreciable base is the value of the asset to be written off over time.
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