How to Determine the Depreciation Rate
How does proration affect asset depreciation?
This means that compared to the straight-line method, the depreciation expense will be faster in the early years of the asset’s life but slower in the later years. However, the total amount of depreciation expense during the life of the assets will be the same. Depreciation expense reduces a business’ profit on its income statement. While the straight-line method reduces profit by the same amount each accounting period, the other two methods cause a company’s profit to fluctuate with all else being equal.
In later years, a lower depreciation expense can have a minimal impact on revenues and assets. However, revenues may be impacted by higher costs related to asset maintenance and repairs. Sum-of-years-digits depreciation is determined by multiplying the asset’s depreciable cost by a series of fractions based on the sum of the asset’s useful life digits.
The double declining balance depreciation (DDB) method, also known as the reducing balance method, is one of two common methods a business uses to account for the expense of a long-lived asset. Similarly, compared to the standard declining balance method, the double declining method depreciates assets twice as quickly. The double declining balance method of depreciation, also known as the 200% declining balance method of depreciation, is a form of accelerated depreciation.
The double-declining-balance method causes lower profit in the earlier years of an asset’s life than in the later years due to the greater depreciation expense in the earlier years. Units-of-production may cause unpredictable profit swings based on the amount of output an asset generates. Double-declining balance is a type of accelerated depreciation method. This method records higher amounts of depreciation during the early years of an asset’s life and lower amounts during the asset’s later years. Thus, in the early years, revenues and assets will be reduced more due to the higher depreciation expense.
Most companies will not use the double-declining balance method of depreciation on their financial statements. The reason is that it causes the company’s net income in the early years of an asset’s life to be lower than it would be under the straight-line method. Depreciation is how the costs of tangible and intangible assets are allocated over time and use. Both public and private companies use depreciation methods according to generally accepted accounting principles, or GAAP, to expense their assets. Depreciation is the allocation of an asset’s cost over its useful life.
Calculate the depreciation expenses for 2011, 2012 and 2013 using 150 percent declining balance depreciation method. A double-declining balance depreciation method is an accelerated depreciation method that can be used to depreciate the value of the asset over the useful life of the asset. It is a bit complex method than the straight-line method of depreciation but is useful for deferring tax payments and maintain low profitability in the early years. One reason for using double-declining balance depreciation on the financial statements is to have a consistent combination of depreciation expense and repairs and maintenance expense during the life of the asset.
Under thedouble 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.
On April 1, 2011, Company A purchased an equipment at the cost of $140,000. At the end of the 5th year, the salvage value (residual value) will be $20,000. Calculate the depreciation expenses for 2011, 2012 and 2013 using double declining balance depreciation method. Accrual-based accounting requires a business to match the expenses it incurs with the revenues it generates each accounting period. Because a long-term asset, such as a piece of equipment, contributes toward revenues over many accounting periods, a company spreads the asset’s cost over its useful life using depreciation.
DDB Depreciation Formula
For the double-declining balance method, revenues and assets will be reduced more in the early years of an asset’s life, due to the higher depreciation expense, and less in the later years. To calculate depreciation expense, use double the straight-line rate. For example, suppose a business has an asset with a cost of 1,000, 100 salvage value, and 5 years useful life. Since the asset has 5 years useful life, the straight-line depreciation rate equals (100% / 5) or 20% per year.
- It is expected that the fixtures will have no salvage value at the end of their useful life of 10 years.
- Under the straight-line method, the 10-year life means the asset’s annual depreciation will be 10% of the asset’s cost.
- Let’s assume that a retailer purchases fixtures on January 1 at a cost of $100,000.
This creates a depreciation expense on the income statement each accounting period equal to a portion of the asset’s cost instead of creating an expense for the entire cost all at once. The double-declining balance method is a type of accelerated depreciation method that calculates a higher depreciation charge in the first year of an asset’s life and gradually decreases depreciation expense in subsequent years.
Sum-of-years digits is a depreciation method that results in a more accelerated write off of the asset than straight line but less than double-declining balance method. This method will reduce revenues and assets more rapidly than the straight-line method but not as rapidly as the double-declining method.
Let’s assume that a retailer purchases fixtures on January 1 at a cost of $100,000. It is expected that the fixtures will have no salvage value at the end of their useful life of 10 years. Under the straight-line method, the 10-year life means the asset’s annual depreciation will be 10% of the asset’s cost.
How do you calculate double declining balance?
First, Divide “100%” by the number of years in the asset’s useful life, this is your straight-line depreciation rate. Then, multiply that number by 2 and that is your Double-Declining Depreciation Rate. In this method, depreciation continues until the asset value declines to its salvage value.
The double-declining balance is a type of accelerated depreciation method that calculates a higher depreciation charge in the first year of an asset’s life and gradually decreases depreciation expense in subsequent years. To calculate depreciation using the double-declining method, its possible to double the amount of depreciation expense under the straight-line method. To do this, divide 100 per cent by the number of years of useful life of the asset. Next, apply the resulting double-declining rate to the declining book value of the asset (cost subtracted by accumulated depreciation). The depreciation method chosen should be appropriate to the asset type, its expected business use, its estimated useful life, and the asset’s residual value.
Apply the rate to the book value of the asset (cost subtracted by accumulated depreciation) and ignore salvage value. At the point where book value is equal to the salvage value, no more depreciation is taken.
A company may choose from different methods of depreciation for financial reporting purposes. Straight line, double-declining balance and units of production are three such methods. Each method differs in the way it allocates an asset’s cost, which can affect your small business’ profit.
In other words, in the early years of the asset’s life, when the repairs and maintenance expenses are low, the depreciation expense will be high. In the later years of the asset’s life, when the repairs and maintenance expenses are high, the depreciation expense will be low. While this seems logical, the company will end up reporting lower net income in the early years of the asset’s life (as compared to the use of straight-line depreciation). Most managers will not accept reporting lower net income sooner than required.
Example of DDB Depreciation
Depreciation expense affects the values of businesses and entities because the accumulated depreciation disclosed for each asset will reduce its book value on the balance sheet. Generally the cost is allocated as depreciation expense among the periods in which the asset is expected to be used. Such expense is recognized by businesses for financial reporting and tax purposes. You cannot use MACRS depreciation tables to report the same depreciation expenses on your audited financial statements as you do on your tax returns under generally accepted accounting principles.
Sum-of-years’ digits is a depreciation method that results in a more accelerated write-off than straight line, but less accelerated than that of the double-declining balance method. Under this method, annual depreciation is determined by multiplying the depreciable cost by a series of fractions based on the sum of the asset’s useful life digits. The sum of the digits can be determined by using the formula (n2+n)/2, where n is equal to the useful life of the asset. Depreciation is defined as the expensing of an asset involved in producing revenues throughout its useful life. Depreciation for accounting purposes refers the allocation of the cost of assets to periods in which the assets are used (depreciation with the matching of revenues to expenses principle).