Double Declining Balance Depreciation Method
Investing Lesson 4 - Analyzing an Income Statement
With the straight line depreciation method and the sum of the years' digits depreciation method out of the way, let's turn our attention to another accelerated depreciation method known as double declining balance depreciation. Think of the double declining balance depreciation method like the straight-line depreciation method, but only on steroids. It seeks to take most of the depreciation charges upfront, in the early years, lowering profits on the income statement sooner rather than later under the theory that most assets lose most of their value shortly after being acquired rather than evenly over a longer period of time.
How to Calculate Double Declining Balance Depreciation Method
Get your calculator ready or your spreadsheets at hand because calculating the double declining balance depreciation method is a bit more work than the other methods we've discussed thus far.
There are really two versions of the double declining balance method, the 150% version and the 200% version. For the sake of illustration, it would be easiest to explain it to you by walking you through a hypothetical example. Let's use the same numbers I had you practice in the sum of the years' digits depreciation expense calculation (follow the link mentioned at the top of the article). Assume that you had a $100,000 asset that will be worth $10,000 at the end of its useful life, giving you a balance subject to a depreciation of $90,000. Furthermore, assume that the useful life of the asset is ten years.
- Taking the $100,000 asset acquisition value and subtracting the $10,000 estimated salvage value, we know that there is $90,000 subject to depreciation. Under the straight line method, we would take $90,000 and divide it by the number of years the asset is expected to remain in service, in this case, 10. Depreciation expense would have been $9,000 each year.
- In this case, we take the $9,000 would-be depreciation expense and figure out what it is as a percentage of the amount subject to depreciation, which is $90,000 in our illustration. By taking $9,000 and dividing it into $90,000, we arrive at 0.10, or 10.00%.
- Now, since we are using the 200% method, we are going to tax 2 x 10.00% to get to 20.00%. (If we had been using the 150% double declining depreciation method, we would have taken 1.5 x 10.00%).
- At this point, we need to apply a 20% depreciation rate to the carrying value of the asset at the beginning of each year. Pay attention to that as it can be a common mistake to apply it to the amount subject to depreciation, which is incorrect. This will continue until the final year, in which a special adjustment will need to be made to complete the depreciation and bring the asset to salvage value.
It might help to see the calculation in chart form like I showed you in the last depreciation exercise we did.
Depreciation Calculation Using the 200% Double Declining Balance Depreciation Method
|Year||Applicable Percentage Depreciation Rate||Starting Carrying Value||Depreciation Expense||Ending Carrying Value|
|10||20.00%||$13,421.77||$2,684.35 + $737.42 special adjustment for final year||$10,000.00|
That final year adjustment was calculated because the carrying value at the end of the ten-year period would have been $10,737.42 but we know that the salvage value was $10,000.00 and should be the correct ending number.