Definition
Declining Balance Depreciation is a method used to calculate depreciation for income tax purposes. Under this method, a constant rate of depreciation is applied to the declining book value of the asset each year, rather than to its original cost. This means that larger depreciation expenses are recognized early in the asset’s life, and smaller expenses are recognized later, which can be advantageous for assets that decline more rapidly in value.
Examples
Let’s consider a property with a tax basis of $10,000 and a depreciable life of 5 years. Using different methods, the depreciation would be calculated as:
-
Straight-Line Method (SLM): The depreciation each year is constant.
- Annual Depreciation = Tax Basis / Useful Life = $10,000 / 5 = $2,000 per year
-
Declining Balance Method at 125%: This method results in larger depreciation deductions earlier.
- Annual Percentage Rate = 125% of 20% (which is the rate for SLM) = 25%
Below is the resultant depreciation schedule using the 125% Declining Balance Method:
| Year | Beginning Balance | Depreciation (25%) | Ending Balance |
|---|---|---|---|
| 1 | $10,000 | $2,500 | $7,500 |
| 2 | $7,500 | $1,875 | $5,625 |
| 3 | $5,625 | $1,406 | $4,219 |
| 4 | $4,219 | $1,055 | $3,164 |
| 5 | $3,164 | $791 | $2,373 |
Frequently Asked Questions (FAQs)
What is Declining Balance Depreciation?
Declining Balance Depreciation calculates depreciation by applying a constant depreciation rate to the book value of the asset each year, resulting in higher depreciation expenses initially and decreasing expenses over time.
How does Declining Balance Depreciation differ from Straight-Line Depreciation?
While Straight-Line Depreciation spreads the expense evenly over the asset’s useful life, Declining Balance Depreciation accelerates expenses by applying a constant rate to the asset’s remaining book value.
Why would a business use Declining Balance Depreciation?
Businesses might use Declining Balance Depreciation to accelerate depreciation expenses in the initial years, thus reducing taxable income when the asset contributes most to revenue generation.
Is Declining Balance Depreciation used for tax purposes?
Yes, it is commonly used for tax reporting because it more accurately reflects the usage and aging of depreciable assets during their most productive years.
How is the depreciation rate determined in Declining Balance Depreciation?
The depreciation rate in Declining Balance Depreciation is often a multiple of the straight-line rate. Commonly used rates include 125%, 150%, and 200%.
Related Terms with Definitions
- Accelerated Depreciation: Methods like Declining Balance Depreciation and Double Declining Balance that allow for higher depreciation charges in the earlier years of the asset’s life.
- Modified Accelerated Cost Recovery System (MACRS): The current tax depreciation system in the United States, which is a type of accelerated depreciation.
- Straight-Line Depreciation: A method that spreads the cost of the asset evenly over its useful life.
- Book Value: The value of an asset according to its balance sheet account balance, which represents its cost less accumulated depreciation.
- Depreciable Life: The length of time an asset is expected to be in use.
Online Resources
- IRS Publication 946: How to Depreciate Property
- Accountant’s Office: A Guide to Declining Balance Depreciation
- Journal of Accountancy: Depreciation Methods Explained
References
- Internal Revenue Service. “Publication 946: How to Depreciate Property,” https://www.irs.gov/publications/p946.
- Kieso, D.E., Weygandt, J.J., & Warfield, T.D. “Intermediate Accounting,” Wiley.
- Radebaugh, L.H., Gray, S.J., & Black, E.L. “International Accounting and Multinational Enterprises,” John Wiley & Sons.
Suggested Books for Further Studies
- Kieso, D.E., Weygandt, J.J., & Warfield, T.D. “Intermediate Accounting,” Wiley.
- Pratt, J., “Financial Accounting in an Economic Context,” Wiley.
- Anthony, R., Hawkins, D., & Merchant, K. “Accounting: Texts and Cases,” McGraw-Hill.
