Declining balance depreciation is a method of measuring an asset’s depreciation value based on its depreciation rate, applying the rate until the value reaches the salvage value. This differs from the straight-line method, and is often used in conjunction with it to produce double-declining-balance depreciation.
Declining balance depreciation is a method of measuring the depreciation value of an asset that is based on the depreciation rate of the asset. Apply the depreciation rate over the life of the asset until the value reaches the salvage value. This differs from the straight-line method of depreciation, in which the amount of depreciation is distributed evenly over the life of the asset. In contrast, the declining balance method of depreciation continues to apply the depreciation rate to the asset’s balance of value, which means that the amount of depreciation decreases each year.
Depreciation is the amount by which an asset decreases over the time it is used. When a company files a tax return, the depreciation values of its assets must be considered. For example, a five-year-old computer will not have the same value as a new one. The declining balance method of depreciation is often used because companies often calculate the expense of an asset when it is new and therefore prefer the expense to decrease as the years go by.
For example, imagine that an asset valued at $500 US dollars (USD) will depreciate at a rate of 50 percent each year. Using declining balance depreciation, that means the value of that asset would depreciate by 50 percent of $500, or $250, in the first year, meaning its year two value would be $ 250 USD, or $500 USD minus $250 USD. In the second year, the $250 balance would depreciate by 50 percent, removing another $125 of value. This process would continue until the value reached the default redemption value of the asset.
Although it differs from the straight-line method, in which an asset depreciates the same amount each year, declining balance depreciation is often used in conjunction with this method. This technique produces what is known as double-declining-balance depreciation. In this method, the straight-line method is used to determine the depreciation rate, which is then doubled to provide the rate for the declining balance method.
As an example, an asset worth $500 USD with a life expectancy of five years would depreciate $100 each year using the straight-line method. This means that the asset depreciates at 20 percent per year, since $100 USD is 20 percent of $500 USD. To use the double-declining method, this 20 percent is doubled to produce a depreciation rate of 40 percent. That rate is then plugged into the declining balance method to determine the amount of depreciation each year.
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