Depreciation: Declining Balance: Videos & Practice Problems

Depreciation is a crucial accounting concept that allows businesses to allocate the cost of a fixed asset over its useful life. One of the more complex methods of calculating depreciation is the double declining balance (DDB) method, which is an accelerated depreciation technique. This method allows for higher depreciation expenses in the early years of an asset's life, which can lead to lower taxable income and, consequently, lower taxes during those years.

To effectively use the double declining balance method, three key variables must be established: the cost of the asset, the estimated useful life, and the residual value (also known as salvage or scrap value). The cost is the initial expenditure for the asset, while the useful life is the period over which the asset is expected to generate revenue. The residual value is the estimated worth of the asset at the end of its useful life. Both the useful life and residual value are estimates and can vary based on the asset and its usage.

The DDB method involves a few systematic steps. First, the depreciation rate is calculated using the formula:

Depreciation Rate = 2 × (1 / Useful Life)

This rate is applied to the asset's net book value at the beginning of each year. For example, if an asset has a useful life of 10 years, the depreciation rate would be:

Depreciation Rate = 2 × (1 / 10) = 0.2 or 20%

In the second step, the depreciation expense for the year is calculated by multiplying the depreciation rate by the beginning net book value of the asset. The net book value decreases each year as depreciation is applied. The formula for calculating the depreciation expense is:

Depreciation Expense = Depreciation Rate × Beginning Net Book Value

After calculating the depreciation expense, the new net book value is determined by subtracting the depreciation expense from the beginning net book value:

New Net Book Value = Beginning Net Book Value - Depreciation Expense

This process is repeated annually, using the new net book value for the subsequent year's calculations. Importantly, the residual value is not considered until the final year. In the last year, the depreciation expense is adjusted to ensure that the net book value equals the residual value, which is referred to as a "plug." This approach distinguishes the DDB method from the straight-line method, where the residual value is deducted before calculating annual depreciation.

In summary, the double declining balance method is a powerful tool for businesses looking to maximize tax benefits in the early years of an asset's life. By understanding the calculation steps and the significance of the depreciation rate, businesses can effectively manage their fixed asset costs and financial reporting.

When a company purchases an asset, such as a delivery truck, it must account for depreciation over the asset's useful life. In this example, Johnson and Johnson and Johnson Company acquired a truck for $42,000, with an estimated useful life of 5 years and a residual value of $2,000. To calculate depreciation using the double declining balance method, the first step is to determine the depreciation rate. This is calculated as:

Depreciation Rate = \(\frac{1}{\text{Useful Life}} \times 2\)

For this truck, the useful life is 5 years, so the rate becomes:

Depreciation Rate = \(\frac{1}{5} \times 2 = 0.4\) or 40%

In the first year, the depreciation expense is calculated by multiplying the depreciation rate by the initial cost of the truck:

Depreciation Expense = Cost \(\times\) Depreciation Rate = 42,000 \times 0.4 = 16,800

The accumulated depreciation at the end of year 1 is $16,800, leading to a net book value calculated as:

Net Book Value = Cost - Accumulated Depreciation = 42,000 - 16,800 = 25,200

For subsequent years, the process continues using the new net book value. In year 2, the depreciation expense is:

Depreciation Expense = 25,200 \times 0.4 = 10,080

Accumulated depreciation at the end of year 2 becomes:

Accumulated Depreciation = 16,800 + 10,080 = 26,880

The new net book value is:

Net Book Value = 42,000 - 26,880 = 15,120

This pattern continues for each year, adjusting the beginning net book value and calculating the depreciation expense accordingly. By year 3, the depreciation expense is:

Depreciation Expense = 15,120 \times 0.4 = 6,048

Accumulated depreciation at the end of year 3 is:

Accumulated Depreciation = 26,880 + 6,048 = 32,928

Resulting in a net book value of:

Net Book Value = 42,000 - 32,928 = 9,072

In year 4, the depreciation expense is:

Depreciation Expense = 9,072 \times 0.4 = 3,629 (rounded)

Accumulated depreciation becomes:

Accumulated Depreciation = 32,928 + 3,629 = 36,557

Leading to a net book value of:

Net Book Value = 42,000 - 36,557 = 5,443

In the final year, the depreciation expense is adjusted to ensure the net book value equals the residual value of $2,000:

Depreciation Expense = 5,443 - 2,000 = 3,443

Thus, the total accumulated depreciation at the end of year 5 is:

Accumulated Depreciation = 36,557 + 3,443 = 40,000

Finally, the net book value matches the residual value:

Net Book Value = 42,000 - 40,000 = 2,000

Once the asset is fully depreciated, no further depreciation is recorded, and the net book value remains at the residual value of $2,000.