Learn Double Declining depreciation method with examples

Dec 25, 2022by Sianna Shah

Double Declining Depreciation

Are you looking for a comprehensive explanation of the double-declining balance method? If so, this blog post is for you! The double declining balance (DDB) method is an accounting technique that helps to calculate depreciation expenses over time.

This article will help explain this method and how it works, including why it can be beneficial.

What is the Double Declining Balance Method?

The Double Declining Balance (DDB) depreciation model is an accounting method of accelerated depreciation that allocates a larger portion of an asset's cost to the earlier years of its useful life. This results in higher depreciation expenses in the initial years after an asset is purchased and lower expenses in the later years. This approach reflects that some assets (like vehicles or machinery) lose value more rapidly in their initial years of use.
The formula for calculating depreciation expense using the DDB method is as follows:

Depreciation Expense=2×Straight-Line Depreciation Rate×Book Value at Beginning of Year

Where:

• The Straight-Line Depreciation Rate is calculated as .
• The Book Value at the Beginning of Year is the cost of the asset minus any accumulated depreciation from previous years.

Key characteristics of the DDB method include:

• Accelerated Depreciation: It charges more depreciation in the early years of an asset's life and less depreciation in later years.
• Not reducing the asset's book value to zero: The method typically does not depreciate an asset to its salvage value (the estimated value of an asset at the end of its useful life). Companies often switch to straight-line depreciation when the annual depreciation expense under DDB becomes less than the straight-line method would calculate, or they deduct the salvage value in the final year of depreciation so as not to go below the salvage value.
• Suitability: It is most suitable for assets that quickly lose their value or become obsolete.

The depreciation method can significantly impact a company's financial statements and tax obligations, making it essential for businesses to select the method that most accurately reflects their assets' usage and value over time.

Advantages of the Double Declining Balance Method

The double declining balance method has several advantages over other methods of depreciation. These advantages include the following:

1. Accelerated Expense Recognition: Allocates more early-year depreciation, matching expense timing with asset utilization.
2. Tax Savings: Higher initial depreciation reduces early-year taxable income, potentially lowering tax liabilities and improving cash flow.
3. Reflects Asset Wear and Tear: Accurately mirrors the faster depreciation of assets in their initial usage years.
4. Improved Cash Flow: Front-loaded depreciation can enhance cash flow by deferring taxes in the short term.
5. Flexibility in Financial Planning: Decreasing depreciation expense over time aids in long-term financial planning and budgeting.
6. Matching Principle: Aligns costs with revenues by recognizing higher expenses when the asset's productivity is highest.
7. Suitable for Rapidly Depreciating Assets: This is ideal for assets that lose value quickly or become technologically outdated early in their lifespan.

Disadvantages of the double declining balance method

The Double Declining Balance (DDB) depreciation method, while beneficial in certain contexts, also has its disadvantages. Here are some key points to consider:

1. Complexity: The DDB method is more complex to calculate and maintain than simpler methods like straight-line depreciation, requiring more detailed accounting work.
2. Reduced Profits in Early Years: Higher depreciation expenses in the early years can significantly reduce reported profits, potentially affecting stakeholders' perceptions and the company's valuation.
3. Inconsistent Expense Allocation: The varying annual depreciation expenses can complicate budgeting and financial analysis, making it harder to compare performance across periods.
4. Limited to Certain Assets: Not all assets depreciate faster in their early years; for such assets, the DDB method may not accurately reflect their usage or value over time.
5. Potential for Underestimating Future Costs: As depreciation expense decreases over time, there might be a tendency to underestimate the impact of future costs related to the asset, such as maintenance.
6. Asset Value Concerns: The method can quickly reduce an asset's book value, which may not align with the actual market value or replacement cost, especially for assets with longer useful lives.
7. Switching Methods May Be Necessary: Companies might need to switch to another depreciation method later in the asset's life to ensure the book value doesn't fall below the salvage value, adding to the accounting complexity.

Overall, the double declining balance method has some potential disadvantages that businesses should consider before using it, including higher depreciation expense in the early years, lower tax benefits in the later years, complexity, and potential inaccuracy in representing the asset's value over time.

How to calculate Double Declining Balance Method depreciation

To calculate depreciation using the Double Declining Balance Method, the following steps should be followed:

1. Determine the asset's initial cost: This includes the purchase price of the asset as well as any additional costs required to get it ready for use (e.g., installation fees and shipping costs).
2. Determine the asset's useful life: This is the length of time that the asset is expected to be used by the business. The useful life can be determined based on industry standards, the manufacturer's recommendations, or the company's experience with similar assets.
3. Determine the asset's salvage value: This is the asset's estimated value at the end of its useful life after all depreciation has been taken. The salvage value is subtracted from the initial cost to determine the asset's depreciable base.
4. Determine the depreciation rate: The depreciation rate is typical twice the straight line, calculated by dividing one by the number of years in the asset's useful life. For example, if an asset has a useful life of 5 years, the straight-line depreciation rate would be 1/5, or 20%. The Double Declining Balance Method depreciation rate would be 2 x 20%, or 40%.
5. Calculate the annual depreciation expense: The depreciation expense is calculated by multiplying the asset's depreciable base (initial cost minus salvage value) by the depreciation rate. For example, if an asset has an initial cost of $100,000, a useful life of 5 years, and a salvage value of$10,000, its depreciable base would be $90,000 (100,000 - 10,000). If the depreciation rate is 40%, the annual depreciation expense would be$36,000 (90,000 x 0.4).
6. Update the asset's book value: The asset's book value is the asset's remaining value after depreciation. It is calculated by subtracting the annual depreciation expense from the asset's previous book value. For example, if the asset's previous book value was $50,000 and the annual depreciation expense was$36,000, the new book value would be $14,000 (50,000 - 36,000). 7. Repeat the process for each year of the asset's useful life: The process of calculating the annual depreciation expense and updating the asset's book value should be repeated for each year of the asset's useful life until the asset's book value reaches zero or the asset is no longer in use. Double declining balance method formula The formula for calculating depreciation using the double declining balance method is: Depreciation expense = (Asset's book value) * (Depreciation rate) • The asset's book value is the asset's original cost minus the accumulated depreciation. • The depreciation rate is determined by dividing the asset's useful life by 2. For example, if an asset has an original cost of$100,000, a useful life of 10 years, and an accumulated depreciation of $20,000, the depreciation rate would be ten years / 2 = 5%, and the depreciation expense for the current year would be calculated as follows: Depreciation expense = ($100,000 - $20,000) * 5% =$80,000 * 5% = $4,000 This formula calculates the depreciation expense for each year of the asset's useful life until the asset's book value reaches zero or the end of its useful life, whichever comes first. Comparison with other Depreciation methods The double declining balance method, the straight-line method, and the units of production method are all methods of depreciation used to allocate the cost of a fixed asset over its useful life. Here is a comparison of these methods and the situations in which each method may be most appropriate: DDB vs SLM method Aspect Double Declining Balance (DDB) Straight-Line Method (SLM) Depreciation Expense Higher in the early years, decreases over time. Consistent amount each year. Tax Benefits Potentially greater tax savings in the early years due to higher depreciation expenses. Steady tax benefit, with consistent deductions over the asset's useful life. Complexity More complex to calculate due to changing depreciation amounts each year. Simpler and easier to calculate, with a consistent depreciation expense each year. Asset Utilization Matches expense with the asset's usage better for assets that lose value quickly in the first few years. May not accurately reflect the usage pattern of assets that depreciate faster in the early years. Financial Reporting Can lead to lower profits and a lower asset book value in the early years, which might affect financial ratios and stakeholders' view. Provides a uniform impact on profits and asset value, making financial statements easier to predict and compare. Suitability More suited for assets that experience rapid depreciation in the initial years of service. Better suited for assets with a relatively uniform usage and value depreciation over their useful life. Adjustments May require switching to another method towards the end of the asset's useful life to avoid depreciating below salvage value. No need to switch methods, as it straightforwardly leads the asset to its salvage value at the end of its useful life DDB vs Units of production method Aspect Double Declining Balance (DDB) Units of Production (UoP) Basis of Depreciation Based on time (e.g., years of use). Based on output or usage (e.g., miles driven, units produced). Depreciation Expense Higher in the early years, decreases over time. Varies with the level of activity or production; directly correlates with asset use. Tax Benefits Potentially greater tax savings in the early years due to higher depreciation expenses. Depreciation expense matches the actual use, which may lead to variable tax benefits based on production levels. Complexity More complex due to the necessity of recalculating depreciation each year based on the book value. Can be complex to calculate if tracking and estimating units of production or usage is difficult. Asset Utilization Match Better for assets that depreciate faster in the initial years regardless of usage. Perfectly matches depreciation with actual usage or production, making it ideal for assets whose value is tied to usage. Financial Reporting Can lead to lower profits and asset book values in the early years, affecting financial ratios and stakeholders' perception. Provides a fair representation of asset utilization and wear, potentially leading to more accurate financial statements. Suitability Suited for assets that experience rapid depreciation in the initial years of use. Best suited for assets where the wear and tear directly correlate with production or usage, not merely the passage of time. Adjustments May require switching to another method to avoid depreciating below the salvage value towards the end of the asset's life. No need to switch methods as depreciation directly correlates with use, but requires accurate usage or production estimates. Businesses should consider these factors when choosing the most appropriate depreciation method for their assets. Real-World Examples of the double declining depreciation To better understand how the Double Declining Balance Method is used in practice, it can be helpful to look at examples from different industries or contexts. Here are a few examples of how the Double Declining Balance Method might be used: Let's say you have an asset with an initial cost of$10,000, a salvage value of $1,000, and a useful life of 5 years. Using the double declining balance method, we can calculate the depreciation expense for each year: Year 1: Depreciation Expense = ($10,000 - $0) x (2 / 5) =$4,000

Year 2: Depreciation Expense = ($10,000 -$4,000) x (2 / 5) = $2,400 Year 3: Depreciation Expense = ($10,000 - $6,400) x (2 / 5) =$960

Year 4: Depreciation Expense = ($10,000 -$7,360) x (2 / 5) = $384 Year 5: Depreciation Expense = ($10,000 - $7,744) x (2 / 5) =$153.60

Please note that the depreciation expense cannot exceed the asset's book value or reduce it below the salvage value. Adjustments may be necessary in those cases. Also, some jurisdictions may have specific rules or variations on how to apply the double declining balance method, so it's always a good idea to consult applicable accounting standards or regulations.

It's important to note that the Double Declining Balance Method may only sometimes be the most appropriate method for calculating depreciation, as it may result in over-depreciation or not align with the asset's actual usage. In these cases, it may be more appropriate to use a different depreciation method, such as the Straight-Line Method or the Units of Production Method.

When deciding whether to use the double declining balance method, businesses should consider several factors, including:

1. Suitability for different types of assets:

Example: A business purchases a new computer for $1,000 that it expects to use for five years. The business expects the computer to generate significant cost savings in the early years of its use, but it expects the cost savings to decline over time. In this case, the double declining balance method may be more suitable for the computer, as it reflects the expected decline in cost savings over time. 2. Potential tax implications: Example: A business is considering using the double declining balance method for a new office building that it expects to use for 20 years. The business consults with a tax professional, who informs them that the double declining balance method is not allowed for tax purposes in their jurisdiction. In this case, the business would need to use a different depreciation method for tax purposes, such as the straight-line method. 3. Impact on financial statements: Example: A business purchases a new machine for$50,000 that it expects to use for ten years. The business uses the double declining balance method to depreciate the machine. The business calculates the depreciation expense in the first year to be \$5,000 (10% of the machine's original cost). This results in a higher depreciation expense in the first year, which may impact the business's profitability and cash flow.

4. Complexity:

Example: A small business with limited accounting resources is considering using the double declining balance method to depreciate a new piece of equipment. The business determines that the method would require more time and effort to implement than the straight-line method and decides to use the straight-line method instead.

5. Accuracy:

Example: A business purchases a new machine that is expected to generate significant cost savings based on its usage. The business determines that the double declining balance method would not accurately reflect the cost savings generated by the machine and decides to use the units of production method instead.

6. Comparison to other depreciation methods:

Example: A business is considering using the double declining balance method to depreciate a new fleet of vehicles. The business compares the double declining balance method to the straight-line method and the units of production method. It determines that the straight-line method is the most suitable for the vehicles, as they are expected to have a long useful life and regular usage.

Overall, these examples illustrate how businesses can consider the complexity of the method,

• The level of accuracy required the comparison to other depreciation methods,
• The suitability for different types of assets,
• The potential tax implications, and
• the impact on financial statements when deciding whether to use the double declining balance method.

Accounting treatment and disclosure under GAAP

Under both US Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), the double declining balance method is a valid method of depreciation that can be used to allocate the cost of a fixed asset over its useful life.

1. Under U.S. GAAP

Accounting Treatment:

• GAAP allows for the use of various depreciation methods, including DDB, straight-line, and units of production. The choice of method should reflect the pattern in which the entity is expected to consume the asset's future economic benefits.
• An entity must review the asset's residual value, useful life, and depreciation method at least annually and adjust future depreciation if expectations change significantly.

Disclosure:

• The financial statements should disclose the depreciation method(s) used, the amounts of depreciation expense for the period, and the accumulated depreciation balances.
• Any changes in the depreciation method, useful life, or salvage value estimates should also be disclosed, including the justification and effect on the financial statements.

Under IFRS

Accounting Treatment:

• IFRS also permits the use of various depreciation methods, including the DDB method, to allocate an asset's depreciable amount over its useful life. The selected method should reflect how the enterprise consumes the asset's economic benefits.
• Reassessment of the residual value, useful life, and method of depreciation must occur at least at each financial year-end, and adjustments must be made if expectations differ from previous estimates.

Disclosure:

• Entities must disclose the measurement bases used to determine the assets' gross carrying amount and the depreciation methods used.
• The depreciation expense for the period, the gross carrying amount, and the accumulated depreciation (including any accumulated impairment losses) must be disclosed.
• Details of any significant adjustments to the residual values, useful lives, or depreciation methods should be disclosed, including the reasons for the change and the impact on financial results.

While the focus on disclosure and the principle of reflecting the pattern of economic benefit consumption is similar in both GAAP and IFRS, IFRS tends to emphasize a principles-based approach, potentially leading to more frequent reassessments of the asset's useful life and depreciation method. Conversely, GAAP may include more specific rules and exceptions for different types of assets and industries.

Disclosure in the financial statements

n the company's financial statements, the depreciation expense for each year is typically recorded under the "Expenses" section of the income statement. The annual depreciation expense calculated using the Double Declining Balance Method would be included in this amount.

Additionally, the company may provide further detail on its depreciation methods and assumptions in the notes to the financial statements. This may include information on the useful lives and salvage values used for each asset and the depreciation rates and methods applied.

For example, the company may include the following disclosure in the notes to the financial statements:

"The company uses the Double Declining Balance Method to calculate the depreciation expense for its machinery and equipment. These assets' useful lives and salvage values are determined based on industry standards and the company's experience with similar assets. The depreciation rates are calculated as twice the straight-line depreciation rates, which are based on the estimated useful lives of the assets."

It's important to note that the Double Declining Balance Method should be consistently applied yearly and disclosed in the financial statements to provide transparency to investors and other stakeholders.

Summing up

The Double Declining Balance method is an in-depth and comprehensive calculation formula used by accountants to estimate depreciation expenses over time. This blog post will help explain what the DDB method entails, how it works and why it can be beneficial.

If you're interested in learning more about this topic or others like it, we suggest taking an course.