Another type of fixed asset is natural resources, assets a company owns that are consumed when used. These assets are considered natural resources while they are still part of the land; as they are extracted from the land and converted into products, they are then accounted for as inventory (raw materials). Natural resources are recorded on the company’s books like a fixed asset, at cost, with total costs including all expenses to acquire and prepare the resource for its intended use. Straight-line depreciation is efficient, accounting for assets used consistently over their lifetime, but what about assets that are used with less regularity?
- In the determination of capitalized costs, we do not consider just the initial cost of the asset; instead, we determine all of the costs necessary to place the asset into service.
- For example, in the current example both straight-line and double-declining-balance depreciation will provide a total depreciation expense of $48,000 over its five-year depreciable life.
- We will repeat a similar process each year throughout the asset’s useful life or until we reach the asset’s salvage value.
- Depreciation records an expense for the value of an asset consumed and removes that portion of the asset from the balance sheet.
- Sum-of-years-digits is a spent depreciation method that results in a more accelerated write-off than the straight-line method, and typically also more accelerated than the declining balance method.
- The thought process behind the adjustments to fair value under IFRS is that fair value more accurately represents true value.
The declining balance method, also known as the reducing balance method, is ideal for assets that quickly lose their values or inevitably become obsolete. This is classically true with computer equipment, cell phones, and other high-tech items, which are generally useful earlier on but become less so as newer models are brought to market. An accelerated method of depreciation ultimately factors in the phase-out of these assets. Depreciation calculations require a lot of record-keeping if done for each asset a business owns, especially if assets are added to after they are acquired, or partially disposed of. However, many tax systems permit all assets of a similar type acquired in the same year to be combined in a “pool”. Depreciation is then computed for all assets in the pool as a single calculation.
Accounting concept
Depreciation expense is a common operating expense that appears on an income statement. Accumulated depreciation is a contra account, meaning it is attached to another account and is used to offset the main account balance that records the total depreciation expense for a fixed asset over its life. In this case, the asset account stays recorded at the historical value but is offset on the balance sheet by accumulated depreciation. Accumulated depreciation is subtracted from the historical cost of the asset on the balance sheet to show the asset at book value. Book value is the amount of the asset that has not been allocated to expense through depreciation.
It is assumed that land has an unlimited useful life; therefore, it is not depreciated, and it remains on the books at historical cost. A variation on this method is the 150% declining balance method, which substitutes 1.5 for the 2.0 figure used in the calculation. The 150% method does not result in as rapid a rate of depreciation at the double declining method. Accelerated depreciation techniques charge a higher amount of depreciation in the earlier years of an asset’s life. One way of accelerating the depreciation expense is the double decline depreciation method. Download the free Excel double declining balance template to play with the numbers and calculate double declining balance depreciation expense on your own!
- For accounting purposes, companies can use any of these methods, provided they align with the underlying usage of the assets.
- 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).
- First-year depreciation expense is calculated by multiplying the asset’s full cost by the annual rate of depreciation and time factor.
- If, for example, an asset is purchased on 1 December and the financial statements are prepared on 31 December, the depreciation expense should only be charged for one month.
The double declining balance depreciation method is a form of accelerated depreciation that doubles the regular depreciation approach. It is frequently used to depreciate fixed assets more heavily in the early years, which allows the company to defer income taxes to later years. Accelerated depreciation is any method of depreciation used for accounting or income tax purposes that allows greater depreciation expenses in the early years of the life of an asset.
However, there are certain advantages to accelerated depreciation methods. The “double” means 200% of the straight line rate of depreciation, while the “declining balance” refers to the asset’s book value or carrying value at the beginning of the accounting period. Accountants need to analyze depreciation of an asset over the entire useful life of the asset. As an asset supports the cash flow of the organization, expensing its cost needs to be allocated, not just recorded as an arbitrary calculation. If asset depreciation is arbitrarily determined, the recorded “gains or losses on the disposition of depreciable property assets seen in financial statements”8 are not true best estimates. Due to operational changes, the depreciation expense needs to be periodically reevaluated and adjusted.
The company would be able to take an additional $10,000 in depreciation over the extended two-year period, or $5,000 a year, using the straight-line method. Following GAAP and the expense recognition principle, the depreciation expense is recognized over the asset’s estimated useful life. We also address some of the terminology used in depreciation determination that you want to familiarize yourself with. Finally, in terms of allocating the costs, there are alternatives that are available to the company. We consider three of the most popular options, the straight-line method, the units-of-production method, and the double-declining-balance method. After the final year of an asset’s life, no depreciation is charged even if the asset remains unsold unless the estimated useful life is revised.
Microsoft® Excel® Functions Equivalent: DDB
The units-of-production depreciation method bases depreciation on the actual usage of the asset, which is more appropriate when an asset’s life is a function of usage instead of time. For example, this method could account for depreciation of a printing press for which the depreciable base is $48,000 (as in the straight-line method), but now the number of pages the press prints is important. First-year depreciation expense is calculated by multiplying the asset’s full cost by the annual rate of depreciation and time factor. Of course, the pace at which the depreciation expense is recognized under accelerated depreciation methods declines over time.
Example of the double declining balance method
The double-declining method of depreciation accounting is one of the most useful and interesting concepts nowadays. It is also one of companies’ most popular methods of charging depreciation. However, companies should take the utmost care while calculating depreciation expenses through this method, as inaccurate calculations would lead to incorrect charging of depreciation expenses throughout the asset’s life. Then, we need to calculate the depreciation rate, explained under the next heading. In the next step, we need to multiply the beginning book value by twice the depreciation rate and deduct the depreciation expense from the beginning value to arrive at the remaining value.
You’ll have to do more math, or get an accountant’s help
Here’s the depreciation schedule for calculating the double-declining depreciation expense and the asset’s net book value for each accounting period. In case of any confusion, you can refer to the step by step explanation of the process below. Hence, corporate income smoothing tied to ceo stocks and options our calculation of the depreciation expense in Year 5 – the final year of our fixed asset’s useful life – differs from the prior periods. The steps to determine the annual depreciation expense under the double declining method are as follows.
Sometimes, when the company is looking to defer the tax liabilities and reduce profitability in the initial years of the asset’s useful life, it is the best option for charging depreciation. When an asset is sold, debit cash for the amount received and credit the asset account for its original cost. Under the composite method, no gain or loss is recognized on the sale of an asset.
Special Issues in Depreciation
Depreciation rates used in the declining balance method could be 150%, 200% (double), or 250% of the straight-line rate. When the depreciation rate for the declining balance method is set as a multiple, doubling the straight-line rate, the declining balance method is effectively the double-declining balance method. Over the depreciation process, the double depreciation rate remains constant and is applied to the reducing book value each depreciation period.
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. Double declining balance is sometimes also called the accelerated depreciation method. Businesses use accelerated methods when having assets that are more productive in their early years such as vehicles or other assets that lose their value quickly.
Depreciation is charged on the opening book value of the asset in the case of this method. Depreciation is the process by which you decrease the value of your assets over their useful life. The most commonly used method of depreciation is straight-line; it is the simplest to calculate.
