The invest in tax free municipal bonds for lower taxes and risk of depreciation reports higher depreciation charges in earlier years than in later years. The higher depreciation in earlier years matches the fixed asset’s ability to perform at optimum efficiency, while lower depreciation in later years matches higher maintenance costs. However, computing the double declining depreciation is very systematic. It’s ideal to have accounting software that can calculate depreciation automatically.
- The salvage value is what you expect to receive when you dispose of the asset at the end of its useful life.
- Next year when you do your calculations, the book value of the ice cream truck will be $18,000.
- Under a 40% DDB depreciation rate, the book value of the same asset two years later would only be $40,320.
- Depreciation is the process by which you decrease the value of your assets over their useful life.
Of course, the pace at which the depreciation expense is recognized under accelerated depreciation methods declines over time. The declining balance method, also known as the reducing balance method, is ideal for assets that quickly lose their values or inevitably become obsolete. This is classically true with computer equipment, cell phones, and other high-tech items, which are generally useful earlier on but become less so as newer models are brought to market. An accelerated method of depreciation ultimately factors in the phase-out of these assets.
How to Calculate Declining Balance Depreciation
For instance, in the fourth year of our example, you’d depreciate $2,592 using the double declining method, or $3,240 using straight line. Now you’re going to write it off your taxes using the double depreciation balance method. If you’re brand new to the concept, open another tab and check out our complete guide to depreciation. Then come back here—you’ll have the background knowledge you need to learn about double declining balance.
Hence, our calculation of the depreciation expense in Year 5 – the final year of our fixed asset’s useful life – differs from the prior periods. On the whole, DDB is not a generally easy depreciation method to implement. To calculate the depreciation expense of subsequent periods, we need to apply the depreciation rate to the laptop’s carrying value at the start of each accounting period of its life. While you don’t calculate salvage value up front when calculating the double declining depreciation rate, you will need to know what it is, since assets are depreciated until they reach their salvage value. The best reason to use double declining balance depreciation is when you purchase assets that depreciate faster in the early years.
We can incorporate this adjustment using the time factor, which is the number of months the asset is available in an accounting period divided by 12. This is because, unlike the straight-line method, the depreciation expense under the double-declining method is not charged evenly over the asset’s useful life. However, using the double declining depreciation method, your depreciation would be double that of straight line depreciation. While some accounting software applications have fixed asset and depreciation management capability, you’ll likely have to manually record a depreciation journal entry into your software application.
With the double declining balance method, you depreciate less and less of an asset’s value over time. That means you get the biggest tax write-offs in the years right after you’ve purchased vehicles, equipment, tools, real estate, or anything else your business needs to run. The double declining balance (DDB) depreciation method is an approach to accounting that involves depreciating certain assets at twice the rate outlined under straight-line depreciation. This results in depreciation being the highest in the first year of ownership and declining over time. The final step before our depreciation schedule under the double declining balance method is complete is to subtract our ending balance from the beginning balance to determine the final period depreciation expense.
Additionally, it more quickly provides your business with a greater deprecation deduction on your taxes. You calculate it based on the difference between your cost basis in the asset—purchase price plus extras like sales tax, shipping and handling charges, and installation costs—and its salvage value. The salvage value is what you expect to receive when you dispose of the asset at the end of its useful life. At the beginning of the second year, the fixture’s book value will be $80,000, which is the cost of $100,000 minus the accumulated depreciation of $20,000.
The double-declining-balance (DDB) method, which is also referred to as the 200%-declining-balance method, is one of the accelerated methods of depreciation. DDB is an accelerated method because more depreciation expense is reported in the early years of an asset’s useful life and less depreciation expense in the later years. To introduce the concept of the units-of-activity method, let’s assume that a service business purchases unique equipment at a cost of $20,000. Over the equipment’s useful life, the business estimates that the equipment will produce 5,000 valuable items. Assuming there is no salvage value for the equipment, the business will report $4 ($20,000/5,000 items) of depreciation expense for each item produced. If 80 items were produced during the first month of the equipment’s use, the depreciation expense for the month will be $320 (80 items X $4).
Under the double declining balance method the 10% straight line rate is doubled to 20%. However, the 20% is multiplied times the fixture’s book value at the beginning of the year instead of the fixture’s original cost. The double declining balance depreciation method shifts a company’s tax liability to later years when the bulk of the depreciation has been written off. The company will have less depreciation expense, resulting in a higher net income, and higher taxes paid.
Declining Depreciation vs. the Double-Declining Method
Don’t worry—these formulas are a lot easier to understand with a step-by-step example. Accountingo.org aims to provide the best accounting and finance education for students, professionals, teachers, and business owners. It has a salvage value of $1000 at the end of its useful life of 5 years.
How to plan double declining balance depreciation
Double declining balance (DDB) depreciation is an accelerated depreciation method. DDB depreciates the asset value at twice the rate of straight line depreciation. Even if the double declining method could be more appropriate for a company, i.e. its fixed assets drop off in value drastically over time, the straight-line depreciation method is far more prevalent in practice.
Types of Accelerated Depreciation Methods
In the accounting period in which an asset is acquired, the depreciation expense calculation needs to account for the fact that the asset has been available only for a part of the period (partial year). Due to the accelerated depreciation expense, a company’s profits don’t represent the actual results because the depreciation has lowered its net income. The next chart displays the differences between straight line and double declining balance depreciation, with the first two years of depreciation significantly higher. For accounting purposes, companies can use any of these methods, provided they align with the underlying usage of the assets. For tax purposes, only prescribed methods by the regional tax authority is allowed. If the company was using the straight-line depreciation method, the annual depreciation recorded would remain fixed at $4 million each period.
Suppose a company purchased a fixed asset (PP&E) at a cost of $20 million. The difference is that DDB will use a depreciation rate that is twice that (double) the rate used in standard declining depreciation. At the end of 10 years, the contra asset account Accumulated Depreciation will have a credit balance of $110,000.
Visit QuickBooks Online now and get 50% off for three months plus a free guided setup. In this way, the company is not only saving more money, but those deductions also correlate with how rapidly the asset will decline. After all, adding thousands of miles to a delivery truck in its early years will cause it to deteriorate in value quickly. Alicia Tuovila is an accounting and finance writer based in Tennessee. Under straight-line depreciation, the depreciation expense would be $4,600 annually—$25,000 minus $2,000 x 20%.
Instead, each accounting period’s depreciation expense is based on the asset’s usage during the accounting period. The double-declining balance (DDB) method is an accelerated depreciation method. After taking the reciprocal of the useful life of the asset and doubling it, this rate is applied to the depreciable base—also known as the book value, for the remainder of the asset’s expected life. Using an accelerated depreciation method has financial reporting implications.
Alternatively, public companies tend to shy away from accelerated depreciation methods, as net income is reduced in the short-term. A variation on this method is the 150% declining balance method, which substitutes 1.5 for the 2.0 figure used in the calculation. The 150% method does not result in as rapid a rate of depreciation at the double declining method.