Fixed assets include resources that companies use to generate economic benefits in the long run. Usually, these consist of property, plant, and equipment. For example, a company’s fixed assets may contain land, building, vehicles, computers, etc. These assets fall under non-current assets in the balance sheet. However, they also impact the income statement.
When a company acquires a fixed asset, it cannot charge the total amount to the income statement. This requirement comes from accounting standards and principles. More particularly, the matching principle in accounting requires companies to charge expenses in the year to which they relate. However, fixed assets do not constitute an expenditure for a specific period. They relate to a longer period.
However, that does not imply that companies must not charge a cost related to them in the income statement. As mentioned, this charge falls under the matching principle. The process under which companies do so is known as depreciation. There are several methods of calculating depreciation, including the double-declining balance method. However, it is crucial to understand what depreciation is first.
What is Depreciation?
The term depreciation, in accounting, relates to the allocation of a fixed asset’s cost over its life. In other words, it is an accounting method used to divide an asset’s cost over its useful life or life expectancy. Through this process, companies can reduce their value in the same year as they generate revenues. Depreciation also represents the total reduction in the value of a fixed asset.
As mentioned, there are several methods under which companies charge depreciation to their accounts. Each technique involves a specific calculation and can result in a different reduction. However, none of these methods provides an accurate estimate of the asset’s usage. Despite that, companies must judge which technique produces the most accurate results based on their estimation.
The depreciation process for an asset begins when a company puts an asset into use. However, it must meet the accounting definition set for the term asset. Therefore, it must generate economic benefits and provide returns for the depreciation to apply. If an asset does not meet the above definition, companies cannot charge depreciation for it.
When a company calculates depreciation on a fixed asset, it will charge it to the income statement. However, this depreciation also becomes a part of the balance sheet under a contra asset account. This amount then reduces the related fixed asset’s book value in the financial statement. It also becomes a part of the statement of cash flows. However, it only constitutes a part of the non-cash expenses added to net income.
Overall, depreciation is an expense charged to the accounts for a fixed asset. This amount relates to the asset’s value that a company uses during the period. Therefore, it represents the reduction in the value of a fixed asset over the period due to usage. This process relates to the matching principle in accounting, which requires companies to charge an expense to the period it relates.
What is the Double Declining Method of Depreciation?
The double-declining method (DDB) of depreciation is a technique that companies use to charge depreciation. This method is also known as the reducing balance method, which companies use to account for a fixed asset’s value. The double-declining balance depreciation method uses accelerated depreciation that charges a higher expense initially. However, this charge decreases in the future.
The double-declining balance depreciation method produces a different charge for each period. In contrast, the straight-line method results in a fixed expense every period. In essence, the double-declining balance method uses a double charge compared to the declining balance method. Therefore, it results in a reduction in the underlying asset’s value twice as quickly.
Companies use the double-declining balance method to depreciate fixed assets significantly more in the initial years. Therefore, it can result in deferred income statements for the later years. Similarly, the DDB method uses an asset’s book value to create a depreciation charge. Usually, it also requires a percentage, which dictates how much the depreciation will be.
Overall, the double-declining balance depreciation method is an accelerated depreciation technique. It results in twice the charge to an asset’s value in the financial statements. It can also produce more expenses initially. As mentioned, the standards do not dictate the method to use when depreciating an asset. However, companies can use this method for assets that deter significantly at the start.
How to Calculate Depreciation Under the Double Declining Method?
There is no specific formula for the double-declining method. Companies can create a depreciation charge under this method by following several steps. Usually, they can use the straight-line depreciation percentage and double it to calculate the depreciation under this method. However, companies can also establish a double charge compared to that under the declining balance method.
Companies can use the following steps to calculate the double-declining balance method depreciation.
- Obtain a fixed asset’s opening book value from the balance sheet.
- Determine its useful life and salvage value.
- Deduct the salvage value from the fixed asset’s cost to determine the total depreciable amount.
- Calculate the annual depreciation based on the useful life. This process requires dividing the depreciable amount by the useful life.
- Multiply the opening book value by twice the regular annual rate.
- Reduce the annual depreciation expense from the opening value to calculate the closing value.
Based on the above steps, companies can also make the process straightforward. They can use the following double-declining balance method formula to calculate the depreciation charge.
Depreciation = Opening book value of the fixed asset x Straight-line depreciation percentage x 2
The above formula for the double-declining balance method does not come from accounting standards. However, it encompasses all the above-discussed steps to create a simplified method for calculating depreciation.
Example
A company, ABC Co., purchases a vehicle for $100,000. The company believes the asset’s value will deteriorate significantly more in the initial years compared to later. ABC Co. has traditionally used the double-declining balance method for depreciating assets. Therefore, the company must use the same treatment for this vehicle.
Overall, ABC Co. believes the vehicle to have a useful life of 10 years. Therefore, the straight-line depreciation percentage will be 10% (1/10 years). Based on its calculations, the company calculates the assets to have a salvage value of $0. Therefore, the depreciation charge for the vehicle in the first year will be as follows.
Depreciation = Depreciable value of the fixed asset x Straight-line depreciation percentage x 2
Depreciation = $100,000 x 10% x 2
Depreciation = $20,000
For the next year, the depreciation rate will not be the same. Since the company charged depreciation on the vehicle for the first year, its opening book value has changed. Based on the above calculation, this opening value will be $80,000 ($100,000 cost – $20,000 depreciation). Therefore, the double-declining balance method depreciation for the second year will be as follows.
Depreciation = Opening book value of the fixed asset x Straight-line depreciation percentage x 2
Depreciation = ($100,000 – $20,000) x 10% x 2
Depreciation = $16,000
Therefore, the depreciation charge for each year will reduce due to the decreasing book value. Overall, ABC Co. will continue the same process for ten years until it uses the asset.
Conclusion
Depreciation is a charge created against an asset that represents its usage over the years. There are several methods to calculate this charge, including the double-declining balance method. Usually, the double-declining balance method involves charging double the depreciation compared to the declining balance method. There are several methods required to calculate this depreciation, as mentioned above.
