In addition, capital expenditures (Capex) consist of not only the new purchase of equipment, but also the maintenance of the equipment. The beginning of period (BoP) book value of the PP&E for Year 1 is linked to our purchase cost cell, i.e. However, one counterargument is that it often takes time for companies to utilize the full capacity of an asset until some time has passed.
In the next step, we need to multiply the beginning book value by twice the depreciation rate and deduct the depreciation expense from the beginning value to arrive at the remaining value. We will repeat a similar process each year throughout the asset’s useful life or until we reach the asset’s salvage value. The Double Declining Balance Method (DDB) is a form of accelerated depreciation in which the annual depreciation expense is greater during the earlier stages of the fixed asset’s useful life. This method is more difficult to calculate than the more traditional straight-line method of depreciation. Also, most assets are utilized at a consistent rate over their useful lives, which does not reflect the rapid rate of depreciation resulting from this method.
Double Declining Balance Depreciation Method
DDB is ideal for assets that very rapidly lose their values or quickly become obsolete. This may be true with certain computer equipment, mobile devices, and other high-tech items, which are generally useful earlier on but become less so as newer models are brought to market. In particular, companies that are publicly traded understand that investors in the market could perceive lower profitability negatively.
- However, the management teams of public companies tend to be short-term oriented due to the requirement to report quarterly earnings (10-Q) and uphold their company’s share price.
- The double declining balance method of depreciation, also known as the 200% declining balance method of depreciation, is a form of accelerated depreciation.
- So, the depreciation expense is calculated in the last year by deducting the salvage value from the opening book value.
- As a hypothetical example, suppose a business purchased a $30,000 delivery truck, which was expected to last for 10 years.
- Double declining balance depreciation allows for higher depreciation expenses in early years and lower expenses as an asset nears the end of its life.
The balance of the book value is eventually reduced to the asset’s salvage value after the last depreciation period. However, the final depreciation charge may have to be limited to a lesser amount to keep the salvage value as estimated. This is the fixture’s cost of $100,000 minus its accumulated depreciation of $36,000 ($20,000 + $16,000). The book value of $64,000 multiplied by 20% is $12,800 of depreciation expense for Year 3. The next step is to calculate the straight-line depreciation expense, which is equal to the difference between the PP&E purchase price and salvage value (i.e. the depreciable base) divided by the useful life assumption. The difference is that DDB will use a depreciation rate that is twice that (double) the rate used in standard declining depreciation.
Importance of Double Declining Balance Method
By dividing the $4 million depreciation expense by the purchase cost, the implied depreciation rate is 18.0% per year. The prior statement tends to be true for most fixed assets due to normal “wear and tear” from any consistent, constant usage. As a hypothetical example, suppose a business purchased a $30,000 delivery truck, which was expected to last for 10 years.
Since public companies are incentivized to increase shareholder value (and thus, their share price), it is often in their best interests to recognize depreciation more gradually using the straight-line method. Therefore, the book value of $51,200 multiplied by 20% will result in $10,240 of depreciation expense for Year 4. However, the management teams of public companies tend to be short-term oriented due to the requirement to report quarterly earnings (10-Q) and uphold their company’s share price. In year 5, companies often switch to straight-line depreciation and debit Depreciation Expense and credit Accumulated Depreciation for $6,827 ($40,960/6 years) in each of the six remaining years.
Example of DDB Depreciation
Therefore, by using the double-declining method, i.e., charging high depreciation expenses in initial years, the company can match the cost with the benefit derived through the use of the asset in a better way. We can understand how the depreciation expense is calculated yearly under the double-declining method from the schedule below. For example, last year, the actual depreciation expense, as per the depreciation rate, should have been $13,422 but kept at $12,108.86 to keep the asset at its estimated salvage value. So, the depreciation expense is calculated in the last year by deducting the salvage value from the opening book value. Depreciation is an accounting process by which a company allocates an asset’s cost throughout its useful life.
- The 150% method does not result in as rapid a rate of depreciation at the double declining method.
- Therefore, by using the double-declining method, i.e., charging high depreciation expenses in initial years, the company can match the cost with the benefit derived through the use of the asset in a better way.
- Hence, our calculation of the depreciation expense in Year 5 – the final year of our fixed asset’s useful life – differs from the prior periods.
- For example, last year, the actual depreciation expense, as per the depreciation rate, should have been $13,422 but kept at $12,108.86 to keep the asset at its estimated salvage value.
- Accelerated depreciation is any method of depreciation used for accounting or income tax purposes that allows greater depreciation expenses in the early years of the life of an asset.
It is also useful when the intent is to recognize more expense now, thereby shifting profit recognition further into the future (which may be of use for deferring income taxes). Instead of multiplying by our fixed rate, we’ll link the end-of-period balance in Year 5 to our salvage value assumption. But before we delve further into the concept of accelerated depreciation, we’ll review some basic accounting terminology.
Step 3. Double Declining Depreciation Rate Calculation
A variation on this method is the 150% declining balance method, which substitutes 1.5 for the 2.0 figure used in the calculation. The 150% method does not result in as rapid a rate of depreciation at the double declining method. The final step before our depreciation schedule under the double declining balance method is complete is to subtract our ending balance from the beginning balance to determine the final period depreciation expense. The depreciation expense recorded under the double declining method is calculated by multiplying the accelerated rate, 36.0% by the beginning PP&E balance in each period.
Why Is Double Declining Depreciation an Accelerated Method?
The double-declining balance method is one of the depreciation methods used in entities nowadays. It is an accelerated depreciation method that depreciates the asset value at twice the rate in comparison to the depreciation rate used in the straight-line method. Depreciation is charged on the opening book value of the asset in the case of this method. Of course, the pace at which the depreciation expense is recognized under accelerated depreciation methods declines over time.
Under the straight-line depreciation method, the company would deduct $2,700 per year for 10 years–that is, $30,000 minus $3,000, divided by 10. At the beginning of the second year, the fixture’s book value will be $80,000, which is the cost of $100,000 minus the accumulated depreciation of $20,000. When the $80,000 is multiplied by 20% the result is $16,000 of depreciation for Year 2. This approach is reasonable when the utility of an asset is being consumed at a more rapid rate during the early part of its useful life.