What it means
Depreciation is the accounting process of spreading the cost of a long-lasting asset across the years in which it is used. The simplest approach, straight-line depreciation, charges the same amount every year.
Double declining balance is an accelerated method, meaning that it front-loads the expense. The method starts by working out the straight-line rate, which is 1 divided by the useful life in years.
Double that rate, then multiply it by the asset's book value at the start of each year. Continue until the book value reaches the expected salvage value, which is what the asset is expected to be worth at the end of its life.
Unlike straight-line depreciation, the calculation initially ignores salvage value. The rate is applied to the full cost in the first year, and then to the shrinking book value.
In the final years, the charge is limited so that the asset is never written down below its salvage value. Businesses may choose this method because it matches the cost to the pattern of use.
A delivery van or a laptop often gives most of its value, and needs the most repairs later, so charging more early reflects reality. It also lowers taxable profit sooner where tax rules allow accelerated depreciation, although tax and accounting rules can differ.
The effect on reported profit is worth understanding. Early-year profits are lower than under straight-line, while later-year profits are higher, even though the total depreciation over the asset's life is identical.
Accounting standards require the method chosen to reflect how the asset's benefits are consumed, and it must be applied consistently. Spreadsheet software includes a built-in function for the calculation, but it is worth knowing how it works.
Managers who understand the mechanics can question assumptions about useful life and salvage value, which drive the numbers. A longer life lowers the charge each year, while a shorter life raises it.
In practice
Real-world examples.
Example
A courier company buys a delivery van for $40,000 with a 5-year life. Using double declining balance, it charges $16,000 in the first year, which matches the van's rapid loss of value in its early life.
Example
A software firm buys servers for $100,000 that will become outdated in four years. It chooses an accelerated method because the equipment is most useful and loses value fastest at the start.
Example
A manufacturer buys a machine for $250,000 and uses double declining balance for both internal reports and tax filings. Its finance team forecasts lower profit in the first two years, so it explains the effect to the lenders in advance.
Formula
Calculation
Depreciation rate = 2 / useful life in years
Annual depreciation = book value at start of year x depreciation rate
(In the final year, depreciation is limited so book value does not fall below salvage value.)
Worked example: A company buys equipment for $50,000. It has a useful life of 5 years and a salvage value of $5,000.
Rate = 2 / 5 = 40%.
Year 1: $50,000 x 40% = $20,000. Book value at end = $30,000.
Year 2: $30,000 x 40% = $12,000. Book value at end = $18,000.
Year 3: $18,000 x 40% = $7,200. Book value at end = $10,800.
Year 4: $10,800 x 40% = $4,320. Book value at end = $6,480.
Year 5: $6,480 x 40% would be $2,592, but that would take the book value below $5,000. Depreciation is limited to $6,480 - $5,000 = $1,480. Book value at end = $5,000.
Total depreciation = $20,000 + $12,000 + $7,200 + $4,320 + $1,480 = $45,000, which equals cost minus salvage value ($50,000 - $5,000).Case study
Seen in the real world.
Riverside Printing is a fictional company that bought a new press for $200,000 with a 5-year life and $20,000 salvage value. The finance manager compared straight-line and double declining balance for the board.
Straight-line depreciation would be $36,000 each year. Double declining balance gave $80,000 in the first year, $48,000 in the second and $28,800 in the third. In this illustrative case, the board was concerned that lower early profits might worry the bank.
The finance manager showed that cash flow was identical under both methods, since depreciation is not a cash cost. The bank accepted the explanation and the company chose the accelerated method. The illustrative lesson is that depreciation methods change reported profit, not cash.
Watch out
Common mistakes.
- Subtracting salvage value before applying the rate. In this method the rate is applied to the full book value, and salvage only limits the final write-down.
- Depreciating below salvage value. The book value should stop at the expected salvage amount.
- Thinking the method saves cash. Depreciation is a non-cash expense, so cash flow is affected only through any tax differences.
Questions
People also ask.
Why is it called double declining?
Because it uses twice the straight-line rate on a declining book value.
When should a company use it?
When an asset provides more benefit or loses more value in the early years, and the method is allowed under the relevant accounting and tax rules.
Does total depreciation differ from straight-line?
No, the total over the asset's life is the same, but the timing differs.
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