Definition
Written Down Value Method, also known as declining balance method, is a method of calculating depreciation where the value of an asset decreases at a consistent rate over its useful life. Instead of spreading the cost of the asset evenly over its life, this method accelerates depreciation so that higher depreciation expenses are recorded during the earlier years of an asset’s life. This method reflects the consumption of the economic benefits of an asset more accurately as assets are often more productive in their early years.
Key Takeaways
- The Written Down Value Method, also known as the Declining Balance Method, is a system of depreciating fixed assets where the value is reduced at a consistent percentage each year. This means larger depreciation costs are incurred in the earlier years of an asset’s life.
- This method is beneficial in scenarios where assets are likely to lose more value in their initial years after purchase. The write-down value usually reflects a more accurate approximation of the physical or functional value of the asset over time.
- Despite its advantages, the Written Down Value Method can be more complicated to calculate than the straight-line method, particularly for businesses with a large number of depreciable assets. Furthermore, because it results in lower profits in the early years of an asset’s life, it may not be the preferred choice for businesses seeking to optimize their financial performance in the short term.
Importance
The Written Down Value (WDV) method, also known as the declining balance method, is a significant method of calculating depreciation in financial management.
Its importance primarily lies in the fact that it offers a more accurate reflection of the value and usability of an asset over time.
Instead of using the straight-line method, which assumes the same amount of depreciation each year, the WDV method assumes that the asset’s utility and consequently its value decline at a faster rate in the earlier years of its life.
Consequently, higher depreciation is accounted for in the initial years with the amount declining over time.
This method better aligns with the actual wear and tear of many physical assets, in turn reflecting a more realistic value on the balance sheet, and often results in tax benefits due to the higher expenses claimed upfront.
Explanation
The Written Down Value Method, also known as the declining balance method, is a method used to calculate the depreciation of an asset. The main purpose of this method is to allocate the cost of an asset over its usage, which can be an effective way to reflect the actual utility and consumption of the asset over time.
This method is commonly used for assets that lose their value quicker in the initial years of usage. It is more realistic since it assigns more depreciation in earlier years of an asset’s life taking into consideration the wear and tear or obsolete nature of assets.
In regards to what it is used for, the Written Down Value method is normally applied in company financial accounting processes. It can be used to calculate tax liabilities as it can lower taxable income, since depreciation is considered an expense.
In the long run, the method helps to maintain a balance by evenly spreading the cost of an asset over its useful life, thereby mitigating the impact of high upfront costs. Accurate depreciation calculations also promote transparency and accuracy in a company’s financial statements, contributing to better financial health.
Examples of Written Down Value Method
Sure, here’s how the Written Down Value Method, also known as the Declining Balance Method, can be applied in real-world situations:
Vehicle Depreciation: A business buys a delivery truck for $50,000, and estimates it will have a residual or scrap value of $10,000 after 5 years of service. Using the Written Down Value Method, the business will declare greater depreciation expenses in the initial years than in the later years of the asset’s life. This signifies the truck’s highest utility and consequently higher depreciation in its early years.
Machinery/Equipment Depreciation: Manufacturing companies often use this method for machinery or equipment which will be generating more profits in the initial years of use and less as it gets older due to increased maintenance needs and reduced efficiency. For example, a company buys a machine for $100,000, which is expected to last for 6 years. It might use this method to account for higher depreciation initially and less as the machine ages.
Property Depreciation: Real estate development companies might use the Written Down Value Method for buildings or complexes. For instance, a company develops a commercial property for $5 million and expects it to have a lifespan of 20 years. They may use this method to account for higher depreciation costs during the early years of the property’s life, reflecting wear and tear, and less in the later years.
FAQs about Written Down Value Method
What is the Written Down Value Method?
This is a method of depreciation in which the value of an asset is decreased at a constant rate each year. The depreciation expense is calculated on the net book value (cost of asset minus accumulated depreciation) rather than its initial cost.
How is Written Down Value Method calculated?
The calculation for Written Down Value Method involves deducting the depreciation expense from the book value of the asset for each year. The depreciation expense is derived from multiplying the asset’s initial cost by the depreciation rate.
What are the key characteristics of the Written Down Value Method?
The key characteristics of this method are that the depreciation expense is higher in the earlier years of an asset’s life and decreases over time. It also takes into account the principle that the productivity of assets diminishes over time.
What is the advantage of the Written Down Value Method?
This method is particularly advantageous for assets that have the potential to lose most of their value in the initial years of usage. It also spreads the cost of the asset over its useful life in a manner that reflects the utility derived from the asset.
How does Written Down Value Method compare to the Straight Line Method?
Unlike the Straight Line Method, which applies the same annual depreciation expense over the life of an asset, the Written Down Value Method applies a higher depreciation expense in the early years of an asset’s life, which decreases over time.
Related Entrepreneurship Terms
- Depreciation
- Asset Value
- Residual Value
- Depreciable Life
- Depreciation Rate
Sources for More Information
- Investopedia: A comprehensive resource for financial concepts and definitions.
- Accounting Tools: Providing detailed articles about a variety of financial topics.
- CFA Institute: An international organization offering a wide range of financial education and resources.
- Accounting Coach: A website that offers free accounting and bookkeeping training.
