Companies use depreciation to spread the cost of an asset out over its useful life. Depreciation is the act of writing off an asset’s value over its expected useful life, and reporting it on IRS Form 4562. The double declining balance method of depreciation is just one way of doing that.
Your basic depreciation rate is the rate at which an asset depreciates using the straight line method. An asset for a business cost $1,750,000, will have a life of 10 years and the salvage value at the end of 10 years will be $10,000. You calculate 200% of the straight-line depreciation, or a factor of 2, and multiply that value by the book value at the beginning of the period to find the depreciation expense for that period. Download the free Excel double declining balance template to play with the numbers and calculate double declining balance depreciation expense on your own! The best way to understand how it works is to use your own numbers and try building the schedule yourself. If the company was using the straight-line depreciation method, the annual depreciation recorded would remain fixed at $4 million each period.
How to Calculate Double Declining Balance Depreciation
The following section explains the step-by-step process for calculating the depreciation expense in the first year, mid-years, and the asset’s final year. Unlike the straight-line method, the double-declining method depreciates a higher portion of the asset’s cost in the early years and reduces the amount of expense charged in later years. Because the equipment has a useful life of only five years it is expected to quickly lose value in the first few years of use – making DDB depreciation the most appropriate method of depreciation for this type of asset. Consider a widget manufacturer that purchases a $200,000 packaging machine with an estimated salvage value of $25,000 and a useful life of five years. Under the DDB depreciation method, the equipment loses $80,000 in value during its first year of use, $48,000 in the second and so on until it reaches its salvage price of $25,000 in year five. DDB depreciation is less advantageous when a business owner wants to spread out the tax benefits of depreciation over the useful life of a product.
- Also, most assets are utilized at a consistent rate over their useful lives, which does not reflect the rapid rate of depreciation resulting from this method.
- In summary, the choice of depreciation method depends on the nature of the asset and the company’s accounting and financial objectives.
- If the company was using the straight-line depreciation method, the annual depreciation recorded would remain fixed at $4 million each period.
- By dividing the $4 million depreciation expense by the purchase cost, the implied depreciation rate is 18.0% per year.
For reporting purposes, accelerated depreciation results in the recognition of a greater depreciation expense in the initial years, which directly causes early-period profit margins to decline. On the other hand, another factor to remember is that predicting your income can be complicated. Balance sheets are not balanced when you apply a double-balancing method.
The drawbacks of double declining depreciation
The DDB depreciation method is best applied to assets that quickly lose value in the first few years of ownership. This is most frequently the case for things like cars and other vehicles but may also apply to business assets like computers, mobile devices and other electronics. Typically, accountants switch from double declining to straight line in the year when the straight line method would depreciate more than double declining. For instance, in the fourth year of our example, you’d depreciate $2,592 using the double declining method, or $3,240 using straight line. Now you’re going to write it off your taxes using the double depreciation balance method.
However, in a double-declining balance method of depreciation, it will be during the first few years of the asset’s life that more depreciation expense is incurred. That translates into higher depreciation expense at the beginning and much lower at the end. Assume a company purchases a piece of equipment for $20,000 and this piece of equipment has a useful life of 10 years and a salvage value of $1,000. The depreciation rate would be calculated by multiplying the straight-line rate by two.
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We can incorporate this adjustment using the time factor, which is the number of months the asset is available in an accounting period divided by 12. This formula works for each year you are depreciating an asset, except for the last year of an asset’s useful life. In that year, the amount to be depreciated will be the difference between the book value of the asset at the beginning of the year and its final salvage value (this is usually just a small remainder). To get a better grasp of double declining balance, spend a little time experimenting with this double declining balance calculator.
- It also matches revenues to expenses in that assets usually perform more poorly over time, so more expenses are recognized when the performance and income is higher.
- Current book value is the asset’s net value at the start of an accounting period, calculated by deducting the accumulated depreciation from the cost of the fixed asset.
- That can make predicting the evolution of your company’s income more complicated.
- We now have the necessary inputs to build our accelerated depreciation schedule.
- It is expected that the fixtures will have no salvage value at the end of their useful life of 10 years.
- In later years, as maintenance becomes more regular, you’ll be writing off less of the value of the asset—while writing off more in the form of maintenance.
- This differs from other depreciation methods where an asset’s depreciable cost is used.
Remember that the tax bill may increase in the future as it is conceived as a way to save in the short and medium-term. Perhaps you will need to economize on taxes in the future, and the application of double depreciation will affect you in this regard. Yes, there are also some disadvantages that you should consider about this formula.