Definition and Explanation:
Declining balance or reducing balance depreciation method considers the value of assets are largely use or highly contribute to operation at the beginning and then subsequently decline.
That means depreciation expenses that should be charged to certain types of assets are high at first and then low subsequently.
This is the main principle of this depreciation. In other words, the depreciation expenses are subsequently decreased until the value is zero or reaches the residual values.
Declining balance or reducing balance depreciation method means the same thing. Some people call the declining balance method and some people called reducing balance methods.
However, the way how we calculate the depreciation expenses are the same. We will discuss the detail of this method in this article.
Does this depreciation method allow by IFRS?
Well, under IAS 16, there are three methods were mention. They are the straight-line method, the diminishing balance method and the units of production method.
Declining balance and reducing is the way how the diminishing balance method is calculating. That means this method is allowed.
Declining balance formula:
Declining balance formula is quite easy to use and remember if you really understand the principle of it. The following is the formula,
Declining balance formula;
Depreciation Expenses = (Net Books – Residual Value) * Depreciation Rate
- Depreciation expenses are the expenses that charged to assets for a specific period or based on specific systematic ways.
- Carrying Value of Assets is equal to the book value of assets less accumulated depreciation. Carrying Value of Assets is sometimes called the Netbooks Value of Assets.
- Residual value is the value of assets that should remain at the end of its useful life based on expectations.
- Depreciation Rate is the rate provided to certain types of assets. The value of assets should be reduced by this rate.
- Book Value is the capitalization costs of assets. The depreciable value of assets is calculated by the book value less residual value of assets. Accumulated depreciation at the end of the year could not exceed this amount.
How to calculate depreciation expenses using reducing balance method?
Calculating the depreciation expenses using reducing balance method is not too difficult.
To calculate, the information we need is book value ( Costs of assets) of assets, salvages value, depreciation rate, and useful life of assets.
Books value of assets include:
- Its purchase price of fixed assets
- Import duties of assets and non-refundable purchase taxes. Discount and rebate should not take into account.
- Costs to bringing the asset to the location and condition and these costs should also be capitalized.
- And dismantling costs
Second, we need to identify the salvage’s value of assets. We need this to calculate the depreciable value of assets.
After identifying the salvage value of assets, we need to find the depreciation rate and useful life of assets.
Finally, it is time for calculating depreciation expenses. To calculate the first-year depreciation, we just need to deduct the salvage value from the value of the book of the asset.
Then we will get the depreciable value. After that, multiply the depreciable value with the depreciation rate. We will get the first-year depreciation expenses.
The second-year depreciation expenses are calculated by deducting the scrap value from the first year’s net book value then we multiply the remaining amount with depreciation rate. We then get the second year depreciation expenses.
Then follow this step until the end of assets useful life. The last year’s depreciation is normally different between NBV of the year before last year with scrap value. This will make sure that all depreciable values are charged.
The following is the example and it might help to illustrate the above explanation.
For example, your company just bought the computers amount USD 10,000 and the depreciation rate for the computers, based on the company policy 50% reducing balance (declining balance).
The Expected residual value is 2,000 USD. The useful life of assets is expected to be three years.
Here is the calculation,
In this example, we can see that the depreciable amount is 8,000 USD and the first-year depreciation expenses are 4k and 2k respectively.
Last year’s depreciation expenses are the difference between the net book value of the second year and the scrap value. This is to make sure that all depreciable value is charged.