Introducing Double declining balance method
A Double declining balance method is one kind of an enhanced depreciation process. In this process, the value of the leading asset gets depreciation. The depreciation rate is double the depreciation rate of the straight-line method. The depreciation rate is faster than the actual rate. Generally, the speed is twice a time faster than the standard rate of the straight-line procedure. So, its other name of this depreciation is quicker depreciation.
But, it does not mean that the accelerated depreciation will also have a higher depreciation cost. The net asset will have the same depreciation. The prices of it may be higher in the early years of valuable life. However, the depreciation costs will be minimum later if you compare them with the straight-line method.
The Double declining balance method – depreciation
Generally, depreciation has two aspects. It is the real decrement of a fair value or asset. For example, a company is using a product for many years. So, the value of it will reduce at a fixed rate. This reduction in value is the depreciation of the product for that year. Besides, in the accounting report, the main assets’ division and their costs in a certain period is also the depreciation. It is a critical term in the method. It affects the double-declining balance a lot.
The Double declining balance method – different inputs
The asset cost is the unique value of the depreciable expense or the total asset. This cost is the required amount to achieve the support set for its proposed use.
Any asset may lose its productivity and will drop its productive value. The practical or valuable time is when an asset gets for production and can keep its production value.
The other name of the salvage value is scrap value or residual value. It denotes the value of an asset after its practical use by the owner.
Placed in Service
For this purpose, select the starting year or month. The starting month or year means the month or year you have started using your asset for its projected purpose.
You may choose a whole month, mid-month, mid-quarter, or mid-year convention. If it is not possible, then keep the pattern for common full-month.
Year or Period
Put input of 1 or 4 digits. Besides, put a four-digit as the year. You can use it as the actual year.
Double declining balance method formula
The depreciation by using the Double declining balance method is,
The formula = 2 X Depreciation X Expense of the asset.
The double-declining balance formula = 2 X Cost of the Useful Life/asset.
The steps for calculating the depreciation costs by using the Double declining balance method are,
- Firstly, determine the main asset’s cost. Find it out when the company has bought the goods.
- Secondly, find out the recovery price of the asset. The recovery or salvage value is the asset’s selling price after disposing or selling, or it becomes useless.
- Thirdly, determine the functional or helpful lifespan of the asset.
- After that, find out the depreciation rate. The depreciation rate = 1/valuable life.
- Then, determine the depreciation expense. To find out this expense, multiply twice the depreciation rate by the starting period book’s value.
- Subtract the depreciation cost from the first value. In this way, you can compute the last period value.
- Finally, repeat all the steps until you get the save value.
The method is not an easy process in general terms. Besides, it is also not a tricky method. An example can make it easier for the readers.
For example, the Fedcorp company has bought a delivery van for $1000. They also had determined that it will have a useful lifespan of five years. Now the question is how the company would evaluate the double-declining depreciation rate on the purchased delivery van.
Firstly, divide 100% by the five years.
So, 100% divided by five years will be 20%.
Then, multiply the result by 2.
So, 20% x 2 = 40%.
Therefore, the double-declining depreciation rate is 40%. This 40% means a depreciation of $400 for every year for the purchased van. If the depreciable expense becomes lower than the salvage value, stop calculating further depreciation in that year.
Adjustment of the depreciation value
Firstly, look at the charging process of the total costs on the double-declining balance sheet. And also, the charge on the cash flow and income report in detail. We can make the adjustment process easy. So, we may talk about an example of a machine’s double-declining balance.
Now, the company has bought the machine for $100,000. So, the cash or equal asset has a reduction of $100,000. This $100,000 will move to a new place on the balance sheet. And the new position is the plant, asset, and similar line of the sheet. At the same time, you may see a cost of $100,000 in the cash flow report.
After that, you may see a charge of $25,000 to the income report. This charge is the depreciation value in the starting year. Again, the amount will be $18.750 in the next year. It will last after eight years. The company has paid all amount of money at first when they have bought the machine. But, the charge of the total cost took place after some time.
Adjustment of the added depreciation
Moreover, there is an opposite account in the balance sheet. You may add the depreciation costs here each year. Besides, the bill is of plant, asset, and types of kit. However, this type of charge is the added depreciation. It is for the reduction of the asset’s carrying value. From the example, the added or accumulated depreciation is $25,000 after the first year. In the second year, the value will be $43,000. This process will go on up to the eighth year. After eight years, the value will be $89,000.
Suppose the valuable life of the bought machine is over. Then, the carrying worth of the company’s asset will be $11,000. Now, the company will try to sell the asset. The price may be more than the salvage value. If so, then there will be a profit. In that case, the amount will be in the income report. Besides, the price also can be less than the save value. In that case, there will be a loss.
Alternative methods of the Double declining balance method
There are several alternative processes to calculate the per annum depreciation costs of a company. The most common alternate methods are,
- Straight-line method
- Declining balance method
- Units of production
- Sum of years digits
The companies can use any balance method for their accounting purposes. Moreover, they can provide an alignment with the assets’ usage. Besides, the company may allow only the prescribed processes by the local tax authority for the tax. The companies can keep two sets of books. You may tell them financial reports also. Among them, the first one for the tax fillings, and the other one for the investors. However, the companies can use any depreciation method for each set of reports. For minimum taxes, the company tries to show the expenses high. On the other hand, the company wants lower depreciation to establish a maximum profit for the investors.
Conditions to use the Double declining balance method
You can use the method in only two conditions or positions. They are,
- Use this balancing method when the company uses the asset very fast at the primary time of its handy life.
- Use this method to recognize the costs at the prime stage for reducing the profit. Also, use it if you want to defer the taxes.
Advantages of the method
There are many advantages of the Double declining balance method. The followings are the main advantages.
Matching of maintenance costs
Several depreciable assets like vehicles can work well when you buy them new. But, time-to-time, they require enough care. Fortunately, the maintenance of the car is deductible from tax. The double-declining depreciation offered a write-off of more significant tax in the earlier time. That time, you are not writing off the repairing costs.
After some years, taking care of the vehicles became more consistent. So, you may write off more minor of the asset’s value. Besides, you may write off more for maintenance. The annual write-offs will be more stable. It will make a more straightforward prediction of the income.
Covering more purchase cost
You may get more money return if you do an early tax write-off. Besides, this money-back may help you to offset the expense of purchasing an asset. You will pay an immense amount of debt if you have taken an early loan. So, try to reduce the payment each of the times.
Reduction of the tax obligation
Some assets can make more money after purchasing. For example, a mango tree produces mango. You can sell the mangoes and can make money for a long time. Logically, you may pay taxes for that income. But, you have an option to reduce the tax obligation. You can write-off much early on the asset. The value of the investment will decrease day by day. Your income from this source will also reduce. Thus both will have a balance.
Drawbacks of Double declining balance method
- The double-declining balance process has some drawbacks. You can consider these drawbacks if you compare it with the straight-line method. The disadvantages are,
- This method is more complex than the simple straight-line or the traditional way.
- You have to do more calculations. Besides, you may need help from an accountant.
- Because of quarterly forecast tax, you will need to guess the revenue each year. Many things will make it hard to predict the income each year.
- You may use maximum assets regularly over their valuable life. Therefore, it does not make any sense to depreciate them at an enhanced rate. Besides, it does not have any reflection of the asset’s actual use.
- This method skews the company’s success. Suppose the company has less profit in the early years than later. Thus, it will be challenging if you want to measure the real operational profit of the company.
For which asset using double-declining balance depreciation is the best?
DDB (double-declining balance) is the best choice for an asset that loses much practical value in its early period. Ant kind of vehicles is the best examples for this type of purchase.
Are there any problems with using DDB depreciation?
The main problem with this depreciation is you cannot use DDB depreciation for income tax purposes.
Is DDB depreciation precise for me?
DDB method is suitable for the assets that lose their value fast. If your assets are like this, you may use the DDB method.
Is the calculation of double-declining balance depreciation simple?
If you follow the formula of the DDB depreciation, the calculation will be easy. However, it is not so simple as the straight-line method. The straight-line process remains stable throughout the asset’s useful life. But, you have to calculate the depreciation every year based on its book value. Besides, this calculation you have to do at the start of the year.
Wrapping up with Double declining balance method
The Double declining balance method is a fast depreciation process. However, a company can use it to run down the asset’s value over the investment’s useful life. It is not a simple nor a more complicated method. If you compare it with a straight-line process, then it is complex. This process defers the income tax payments. Besides, it maintains low profit in the initial periods of the valuable lifetime of the product. To get the best idea about this method, go through and analyze it.