Declining Balance (or Reducing Balance) Method
The declining balance methods of depreciation recognise the fact that the depreciation of an asset is unlikely to be constant over its useful life, and that depreciation is likely to be greater during the early years of the useful life of the asset. For example, a business buying a new vehicle will be aware that the market value of that vehicle after it is one year old will have dropped considerably, whereas in subsequent years the drop in value will be less marked.
The declining balance method therefore applies a particular percentage to the written down value of the asset to calculate depreciation, that percentage being determined by the estimated useful life of the asset so that its cost or value will have been mostly (but not completely) written down by the end of its useful life. For an asset such as a vehicle that may have an estimated useful life of around ten years, a declining balance method might be applied by writing down the value each year by 25%. Where an asset costs $40,000, the amount of depreciation in the first year would be 25% of $40,000 which is $10,000. This leaves a written down value of $30,000 for the asset.
In the accounts for the second year of the asset’s useful life, the depreciation would be 25% of $30,000, being $7,500. The written down value of the asset on the balance sheet at the end of the second year would therefore be $22,500. By the tenth year the depreciation charge would be only $751 and the written down value of the asset at the end of the tenth year would be $2,252. The declining balance method leaves a residual value at the end of the useful life of the asset, even though this may be very small and may only represent the scrap value of the asset.