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Double-Declining-Balance Depreciation

Lesson
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You've already learned about the straight-line depreciation method.

It's straight-forward, it's easy, it's also problematic.

It assumes that items will lose value at a constant rate, until they've hit their residual value (which may or may not be zero).

There are many things, however, that lose most of their value early in their ownership.

  • New cars are said to lose 30% of their value as soon as they are driven off the lot.
  • Computers that are world-class in terms of processing power are soon overshadowed by newer and more powerful devices.
  • Sailboats tend to lose value extremely rapidly early in their lives and then bottom out at a stable price a number of years later.

The straight-line method under-estimates the depreciation on these items early on, and over-estimates it later on.

For some types of products, it would be wonderful to use a depreciation method that better reflects reality.

Such a method would be more accurate, and it would also offer some significant tax benefits, allowing for greater deductions for the loss of value early in the ownership period.

The phrase double-declining should clue you in that the rate of depreciation is double what it would be under straight line.

Here's how it works:

  1. Divide 1 by the item's lifespan in years.
  2. Double it to find the depreciation rate. This is the percentage that the value of the item that will be reduced each year.
  3. Each year, reduce the item's value by the existing value * the depreciation rate or the remaining value until the salvage value, whichever is lower.

Make sure you remember the following two points, as many accounting students forget:

  • Unlike in straight-line, the depreciation rate is calculated without regard to the salvage value.
  • The depreciation can never take the value of the item below its residual value. If necessary, the depreciation in the final year must be reduced from how it would otherwise be calculated.
Question
Ultra Biz, the beloved wig designer, is examining some equipment that has been depreciated using the double-declining method.

Here are the relevant facts:

  • Its residual value is $1,098.

  • It was acquired for $34,700.

  • It has an expected lifespan of 4 years.


What is the value of the item as of end of year number 2 when using the double-declining depreciation method?
Answer
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👉 Answer:

  • The value as of end of year number 2 is $8,675.00

👨‍🎓 Here's how we arrived at the answer:

  1. The first thing we need to do is figure out the rate of depreciation. Since it's twice the rate of straight-line, we can figure it out pretty easily.
    DEPRECIATION RATE = 2 * (1 / DEPRECIABLE YEARS)
  2. Let's fill in the numbers that we already know.
    DEPRECIATION RATE = 2 * (1 / 4)
  3. Lets do the math out.
    DEPRECIATION RATE = 50.00%
  4. The math is a little complicated, so let's build a table.
    double-declining method
    YearDepreciation BaseRateDepreciationAccumulated DepreciationEnding Value
  5. Now let's fill in another year.
    double-declining method
    YearDepreciation BaseRateDepreciationAccumulated DepreciationEnding Value
    1 $34,700.00 50.00% $17,350.00 $17,350.00 $17,350.00
  6. Now let's fill in another year.
    double-declining method
    YearDepreciation BaseRateDepreciationAccumulated DepreciationEnding Value
    1 $34,700.00 50.00% $17,350.00 $17,350.00 $17,350.00
    2 $17,350.00 50.00% $8,675.00 $26,025.00 $8,675.00
  7. And here we can just read off the ending item value for year 2 from the table ($8,675.00).
    double-declining method
    YearDepreciation BaseRateDepreciationAccumulated DepreciationEnding Value
    1 $34,700.00 50.00% $17,350.00 $17,350.00 $17,350.00
    2 $17,350.00 50.00% $8,675.00 $26,025.00 $8,675.00
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