Double Declining Balance Depreciation Method
Analyzing an Income Statement
Some companies use accelerated depreciation methods to defer their tax obligations into future years. Double declining balance depreciation is one of these methods. It was first enacted and authorized under the Internal Revenue Code in 1954, and it was a major change from existing policy.
This method takes most of the depreciation charges upfront, in the early years, lowering profits on the income statement sooner rather than later.
The theory is that certain assets experience most of their usage, and lose most of their value, shortly after being acquired rather than evenly over a longer period of time.
Lowered profits result in lesser income taxes paid in those earlier years.
Analyze the Income Statement
The double declining balance depreciation method shifts a company's tax liability to later years when the bulk of the depreciation has been written off. The company will have less depreciation expense, resulting in a higher net income, and higher taxes paid. This method accelerates straight-line method by doubling the straight-line rate per year.
Due to the accelerated depreciation expense, a company's profits don't represent the actual results because the depreciation has lowered its net income.
This can make profits seem abnormally low, but this isn't necessarily an issue if the business continues to buy and depreciate new assets on a continual basis over the long term.
How to Calculate Double Declining Balance Depreciation
Companies can use one of two versions of the double declining balance method: the 150% version or the 200% version. The 150% method is appropriate for property that has a longer useful life.
This example uses the 200% version. Assume that you've purchased a $100,000 asset that will be worth $10,000 at the end of its useful life. This gives you a balance subject to a depreciation of $90,000. Assume that the useful life of the asset is ten years.
- Take the $100,000 asset acquisition value and subtract the $10,000 estimated salvage value. You now have $90,000 subject to depreciation.
- You would take $90,000 and divide it by the number of years the asset is expected to remain in service under the straight-line method—10 years in this case. Depreciation expense would be $9,000 each year.
- Take the $9,000 would-be depreciation expense and figure out what it is as a percentage of the total amount subject to depreciation. That works out to $90,000. You'll arrive at 0.10, or 10%, by taking $9,000 and dividing it into $90,000.
- Now multiply 2 x 10% to get to 20%.
- Finally apply a 20% depreciation rate to the carrying value of the asset at the beginning of each year. It's a common mistake to apply it to the original amount subject to depreciation, but that's incorrect.
- This process continues until the final year when a special adjustment must be made to complete the depreciation and bring the asset to salvage value.
You would have taken 1.5 x 10% in Step 4 if you had been using the 150% double declining depreciation method.
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|
The final year adjustment was calculated because the carrying value at the end of the 10-year period would have been $10,737.42, but you know that the salvage value was $10,000.00 and that should therefore be the correct ending number.