Definition
The Double Declining Balance Method is a depreciation accounting technique whereby an asset’s depreciation expense is double the rate of the straight-line depreciation method. It accelerates the recognition of depreciation in the early years of an asset’s life. This method acknowledges that some assets lose value faster in the beginning of their lifecycle than in later years.
Key Takeaways
- The Double Declining Balance Method is an accelerated depreciation method that counts twice as much of the asset’s book value each year as an expense compared to straight-line depreciation.
- This method is typically used for assets that quickly lose value early in their useful life. Because it results in larger depreciation expenses in the early years and smaller ones later, it provides a better match of depreciation expense with the benefit received from the asset due to higher productivity in early years.
- Despite it’s aggressive depreciation, the Double Declining Balance Method never results in a completely depreciated asset. The book value will always be greater than the salvage value until the asset is disposed. Therefore, switches to straight-line depreciation might be necessary to depreciate the asset fully by the end of its useful life.
Importance
The Double Declining Balance Method is an important finance term as it represents a form of accelerated depreciation, a method where higher depreciation expense is recognized during the early years of an asset’s life and gradually decreases over time. This method is beneficial for companies with assets that lose value quickly or become obsolete faster, like tech equipment or vehicles.
By depreciating these assets more aggressively, companies can accurately account for their rapid loss of value. Moreover, it can also substantially lower companies’ taxable income in the first few years of acquiring the asset, providing a short-term tax shield.
Hence, this method plays a crucial role in keeping the financial statements of a company more realistic and tax planning.
Explanation
The Double Declining Balance Method is a form of accelerated depreciation accounting methodology, typically used to recognize the consumption of an asset over its useful life. This method serves an essential purpose when an organization wants to account for more depreciation upfront rather than spreading it evenly over time.
It acknowledges the fact that many assets decline in utility more heavily during the initial years of use. It’s often applied to assets that quickly become obsolete, or where wear and tear will be heavy or burdensome in the early years.
The use of the Double Declining Balance Method can profoundly impact a company’s financial statements and tax liabilities. Higher depreciation expenses in the initial years can result in lower net income reports; however, it also decreases a company’s tax liability for the same period due to lower taxable income.
This method is valuable in the management of profits and in tax planning, allowing companies to control their taxable income better. In deciding whether to use this method, companies should consider the nature of their assets and the financial or tax benefits they wish to achieve.
Examples of Double Declining Balance Method
The Double Declining Balance Method is a type of accelerated depreciation method that provides for a higher depreciation amount during the early years of an asset’s life. Here are three real-world scenarios where it may apply:
Automobile Depreciation: A car dealership buys a fleet of cars for business use. According to tax laws, the value of these cars can be depreciated over time to account for their wear and tear. Using the Double Declining Balance Method, the dealership can apply larger depreciation expenses in the earlier years of the cars’ life, when they are worth more and wearing out more rapidly.
Machinery in a Factory: A manufacturing company purchases expensive machinery to produce goods. Any new machine loses its value faster in the first years due to rigorous use and latest technology introduction. Using the Double Declining Balance Method, the company can account for the faster depreciation of these assets initially, thereby reducing their taxable income initially when the machinery is working at its peak.
IT Equipment: A software company purchases a significant amount of high-end computer hardware. As this type of equipment tends to become obsolete quickly, it may lose value faster at the start of its usable lifespan. Here, the Double Declining Balance Method could be used to better match depreciation charges with the actual loss in value as time passes.
FAQs about Double Declining Balance Method
What is the Double Declining Balance Method?
This method is a form of accelerated depreciation where the depreciation expense is higher in the earlier years and decreases over time. It is calculated by doubling the straight-line depreciation rate. This method is used where assets are expected to lose the majority of their value in the initial years of use.
How is the Double Declining Balance Method calculated?
It’s calculated by doubling the straight-line depreciation for the first year. For each subsequent year, the depreciation is applied to the net book value, which is the cost of the asset minus any accumulated depreciation.
When is it appropriate to use the Double Declining Balance Method?
This method is most suitable for assets that lose their value rapidly, or when the expense and usage are higher in the early years compared to the later years.
What is the difference between straight-line and Double Declining Balance Method?
Straight-line depreciation method spreads the cost evenly over the useful life of an asset, whilst Double Declining Balance Method charges higher costs in the earlier years and decreasing in the later years. The major difference comes from the fact that the Depreciation Expense under Double Declining Balance method is twice the expense under the Straight Line method in the first year.
Are there any disadvantages to the Double Declining Balance Method?
Yes, one major disadvantage is that it might distort a company’s profitability in the earlier years of an asset’s lifespan. It can lead to larger depreciation expenses initially, which decreases profits. However, this will gradually balance out as the depreciation expense decreases over time.
Related Entrepreneurship Terms
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Depreciation
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Book Value
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Net Income
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Accumulated Depreciation
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Salvage Value
Sources for More Information
- Investopedia: This website provides a wide range of financial and investment information, including detailed explanations of complex financial concepts such as the Double Declining Balance Method.
- AccountingTools: This website offers comprehensive accounting information and resources. They provide explanations for different accounting methods, including the Double Declining Balance Method.
- Corporate Finance Institute: The CFI website provides a wide range of resources on finance topics. They have an in-depth section on depreciation, in which they cover the Double Declining Balance Method.
- The Balance: This site offers a variety of detailed articles on personal finance, investing, and retirement planning, and includes information about the Double Declining Balance Method.
