What it means
Some assets do most of their work, or lose most of their value, early in their lives. A new vehicle loses a large part of its market value in its first year; a computer is at its most useful before newer machines make it slow; production equipment runs most reliably before wear sets in and maintenance rises.
For such assets, an even annual charge overstates their value in the later years and understates the cost of using them in the early years. Accelerated methods front-load the charge, and double declining balance does so with a simple rule: take the straight-line rate, double it, and apply it each year to whatever book value remains.
The mechanism produces a geometric series. In the first year the charge is the rate times cost; in the second, the rate times cost less the first year's charge; and so on.
Because the base declines each year, so does the charge, and the book value approaches but never reaches zero. Two conventions deal with the tail.
First, depreciation stops when the book value reaches the asset's estimated salvage value, which acts as a floor; the final year's charge is whatever brings the book value to that figure. Second, because in the later years the declining charge falls below what straight-line depreciation of the remaining balance would give, many companies and most tax systems switch to straight-line for the remaining life at the point where straight-line becomes larger, which depreciates the asset fully and evenly to its salvage value.
Salvage value is treated differently from the straight-line method. Under straight-line it is deducted from cost to find the depreciable base; under double declining balance it is not deducted at the start, because the method's rate is applied to full cost, but it acts as the floor below which the book value cannot go.
For an asset with substantial salvage value, the floor is reached before the end of the useful life, and depreciation stops early; for an asset with no salvage value, the switch to straight-line or a final write-off is needed to clear the last of the book value. The method's most important use is in tax.
Many tax systems allow or require declining balance depreciation for plant, equipment and vehicles, often at double the straight-line rate, as an incentive to invest: the larger deductions in the early years reduce taxable profit and defer tax to later years, when the deductions are smaller. The total deduction over the asset's life is the same as under straight-line, so the benefit is timing, worth the interest on the deferred tax.
A company that uses straight-line in its accounts and double declining balance for tax reports a deferred tax liability for the difference, which builds while the asset is new and unwinds as it ages. For financial reporting, the choice of method should reflect the pattern in which the asset's benefits are consumed, and the choice affects reported results.
Double declining balance depresses profit in the years after an asset is bought and raises it later, so a company investing heavily shows lower profits than it would under straight-line and a company that has stopped investing shows higher ones. It also produces lower book values, which raise return on assets and can produce gains on disposal if assets are sold early.
Readers comparing companies should check which method each uses, and companies changing method must disclose the change and its effect.
In practice
Real-world examples.
Example
A car rental company depreciates its fleet at 40% double declining balance, which tracks the fall in used car values closely enough that gains and losses on disposal are small.
Example
A data centre operator depreciates servers at 50% double declining balance over four years, reflecting the rapid decline in their computing value relative to newer machines.
Example
A manufacturer claims double declining balance for tax on a $2,000,000 production line while using straight-line in its accounts, and reports a deferred tax liability that peaks at $150,000 in year 2.
Think of it
“Double declining balance is aggressive depreciation-double-speed write-offs that slow down over time.
Formula
Calculation
Double declining balance rate = 2 x (1 / Useful life in years) = 2 / Useful life
Depreciation for the year = Opening book value x Rate
Opening book value = Cost minus Accumulated depreciation
Floor: Book value must not fall below Salvage value; the final charge is limited to (Opening book value minus Salvage value)
Switch test: if (Opening book value minus Salvage value) / Remaining years exceeds the declining balance charge, switch to straight-line for the remaining years
Worked example. A delivery truck costs $80,000, has a five-year useful life and an estimated salvage value of $8,000. Straight-line would charge ($80,000 minus $8,000) / 5 = $14,400 a year. The double declining rate is 2 / 5 = 40%.
- Year 1: $80,000 x 40% = $32,000; book value $48,000
- Year 2: $48,000 x 40% = $19,200; book value $28,800
- Year 3: $28,800 x 40% = $11,520; book value $17,280
- Year 4: $17,280 x 40% = $6,912; book value $10,368 (switch test: ($17,280 minus $8,000) / 2 = $4,640, less than $6,912, so no switch)
- Year 5: $10,368 x 40% = $4,147 would take the book value to $6,221, below the $8,000 salvage value, so the charge is limited to $10,368 minus $8,000 = $2,368; book value $8,000
- Total depreciation = $32,000 + $19,200 + $11,520 + $6,912 + $2,368 = $72,000, the same as five years of straight-line, but with 44% of it in year 1
Worked example with no salvage value and a switch. Equipment costs $60,000 with a four-year life and no salvage value. The rate is 50%.
- Year 1: $30,000; book value $30,000
- Year 2: $15,000; book value $15,000
- Year 3: declining balance would give $7,500; straight-line on the remaining $15,000 over 2 years gives $7,500; equal, so either; charge $7,500; book value $7,500
- Year 4: declining balance would give $3,750 and leave $3,750 undepreciated; the switch to straight-line gives $7,500, clearing the balance to zero
Tax effect. At a 25% tax rate, the truck's year 1 deduction under double declining balance exceeds straight-line by $32,000 minus $14,400 = $17,600, deferring $4,400 of tax; the deferral reverses in years 3 to 5.Case study
Seen in the real world.
An equipment rental company bought $4,000,000 of compact construction machinery with an expected five-year life and salvage values of about 20% of cost. Its rental rates for a machine were highest when it was new and fell each year as customers preferred newer equipment, so the company's revenue from each machine declined over its life in roughly the pattern that double declining balance depreciation would follow. The finance director chose double declining balance for the accounts on that basis, so that each year's depreciation matched the year's rental income, and for tax, where it was also permitted.
The first year's depreciation was $1,600,000 (40% of $4,000,000) against rental income from the new fleet of $2,200,000, a margin before other costs of $600,000; the second year's was $960,000 against income of $1,900,000, a margin of $940,000; and so on, with the margin rising as the fleet aged and the depreciation fell, until in year five the depreciation was limited by the salvage floor and the fleet was sold for close to its book value of $800,000. Under straight-line, the depreciation would have been $640,000 every year, and the fleet would have shown a margin of $1,560,000 in its first year and $360,000 in its fifth, a pattern that would have made new fleets look far more profitable than old ones when the reverse was closer to the truth.
The method's value showed when used equipment prices fell sharply in the fourth year and machines that had been expected to fetch $800,000 fetched $600,000. Under double declining balance the fleet's book value was already low, and the loss on disposal was $200,000.
A competitor using straight-line with the same salvage assumption had a book value of $1,280,000 on an equivalent fleet at the same point and took a loss of $680,000, which pushed it into breach of a covenant. The finance director's note to the board observed that double declining balance had matched the company's depreciation to the economics of its business, and that the tax deferral, worth about $150,000 in the first two years, had been a bonus rather than the reason.
Watch out
Common mistakes.
- Applying the doubled rate to the original cost every year instead of to the declining book value, which is simply straight-line at twice the rate and over-depreciates the asset.
- Deducting salvage value from cost before applying the rate; under double declining balance the rate is applied to full cost and salvage value is a floor.
- Continuing the declining charge to the end of the life without a switch or a final adjustment, so that the asset is never fully depreciated to its salvage value.
Questions
People also ask.
What is the difference between double declining balance and declining balance?
Declining balance is the general method of applying a fixed rate to the remaining book value; double declining balance is the version where the rate is twice the straight-line rate. Other multiples, such as 150% declining balance, are also used.
When should double declining balance be used?
For assets that lose value or usefulness quickly in their early years, such as vehicles, computers and technology equipment, and where tax rules allow it as an incentive. It should reflect the pattern in which the asset's benefits are consumed, not simply a wish to reduce early profits or tax.
Does double declining balance change the total depreciation?
No. Over the asset's life, the total is cost less salvage value under any method. Double declining balance charges more in the early years and less in the later ones, which affects the timing of profit and tax but not the total.
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