Learn Double Declining Balance Method of Depreciation with examples

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. 

On this page

• What is the double declining balance method
• Advantages and disadvantages 
• How to calculate DDB
• Double declining balance method formula
• Comparison with other Depreciation methods
• Real-World Examples
• Considerations for using the double declining balance method
• Accounting treatment and disclosure under GAAP

What is the Double Declining Balance Method?

The Double Declining Balance Method calculates the depreciation expense of an asset over its useful life. It is based on the principle of accelerating depreciation, meaning that a more significant portion of the asset's value is depreciated in the early years of its useful life, with depreciation decreasing over time.

The Double Declining Balance Method is often used for assets expected to have a higher level of usage or obsolescence in the early years of their useful life, such as equipment or machinery. It is also commonly used for tax purposes, as it allows for higher tax deductions in the early years of asset ownership.

To calculate depreciation using the Double Declining Balance Method, the asset's initial cost is multiplied by a depreciation rate, which is typical twice the straight-line depreciation rate. The resulting amount is then subtracted from the asset's remaining book value to determine the new book value. This process is repeated each year until the asset's book value reaches zero or the asset is no longer in use.

It's important to note that the Double Declining Balance Method is only one of several methods used to calculate depreciation. The most appropriate method will depend on the asset and business circumstances.

Advantages and Disadvantages  

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. Faster write-off of the asset: Under the double declining balance method, a more significant portion of the asset's cost is allocated to the early years of its useful life. This means the asset is written off faster than it would be under other depreciation methods, such as the straight-line method.
2. Greater tax benefits: Because the double declining balance method writes off the asset faster, it can generate greater tax benefits in the early years of the asset's useful life. This can be particularly beneficial for businesses in a high tax bracket and looking to reduce their tax burden.
3. More accurate representation of the asset's value: Some businesses argue that the double declining balance method accurately reflects the asset's value over time. Because the asset is expected to generate the most value in the early years of its useful life, the double declining balance method allocates a more significant portion of the asset's cost to these early years.
4. Simplicity: The double declining balance method is relatively simple and does not require complex calculating factors such as the asset's residual or estimated disposal value.
5. Flexibility: The double declining balance method allows businesses to adjust the depreciation rate each year based on the asset's remaining book value. This can be particularly beneficial for assets with a shorter useful life or are expected to generate more value in the early years of their use.
6. Matching of expenses and revenues: By allocating a more significant portion of the asset's cost to the early years of its useful life, the double declining balance method can help businesses match their expenses with their revenues more closely. This can be particularly beneficial for businesses that generate most of their revenues early in an asset's use.
7. Increased cash flow: Because the double declining balance method writes off the asset faster, it can generate greater tax benefits in the early years of the asset's useful life. This can increase a business's cash flow and allow it to invest in other areas or opportunities.
8. Improved financial statements: By accurately reflecting the asset's value over time, the double declining balance method can help improve the accuracy and clarity of a business's financial statements.

Disadvantages of the double declining balance method

While the double declining balance method has several advantages, it also has some potential disadvantages that businesses should consider before using it. These disadvantages include the following:

1. Greater depreciation expense in the early years: Because the double declining balance method allocates a more significant portion of the asset's cost to the early years of its useful life, it can result in higher depreciation expenses in these early years. This can impact a business's profitability and cash flow.
2. Lower tax benefits in the later years: Because the double declining balance method writes off the asset faster, it can generate greater tax benefits in the early years of the asset's useful life. However, this means that the tax benefits will be lower later in the asset's useful life.
3. Complexity: While the double declining balance method is relatively simple, it may be more complex than other depreciation methods, such as the straight-line method. This may require businesses to spend more time and resources calculating yearly depreciation expenses.
4. Inaccurate representation of the asset's value: Some businesses argue that the double declining balance method needs to reflect the asset's value over time accurately. Because it allocates a more significant portion of the asset's cost to the early years of its useful life, it may not accurately reflect its value in later years.
5. Risk of overstating depreciation expense: If the asset's useful life is overestimated or the asset is sold before the end of its useful life, the double declining balance method may result in overstating the depreciation expense. This can impact a business's profitability and cash flow.
6. Inability to use for certain assets: The double declining balance method may not be suitable for certain assets, such as intangible assets or assets with a long useful life. In these cases, businesses may need to use a different depreciation method.

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:

1. Accelerated depreciation: The double declining balance method is accelerated, which allocates a more significant portion of the asset's cost to the early years of its useful life. The straight-line method allocates an equal portion of the asset's cost for each year of its useful life, and the units of production method allocate the asset's cost based on its actual usage or productivity.
2. Complexity: The double declining balance method is relatively simple but may be more complex than the straight-line method. The units of production method may be the most complex of the three methods. It requires businesses to track the asset's actual usage or productivity and calculate the depreciation expense based on this usage.
3. Accuracy: The units of production method is generally considered the most accurate depreciation method based on the asset's actual usage or productivity. The double-declining balance and straight-line methods may need to be more accurate in certain situations, as they need to consider the asset's actual usage and productivity.
4. Tax implications: Each method may have different tax implications, depending on the jurisdiction and the specific tax laws that apply. Businesses should consult with a tax professional or review relevant tax laws to determine the tax implications of each method.
5. Suitability for different types of assets: Each of the three methods may be more or less suitable for different types of assets, depending on the characteristics of the asset and the business's needs. For example, the double declining balance method may be more suitable for assets with a short useful life or expected to generate significant revenues or cost savings in the early years of their use. The straight-line method may be more suitable for assets with a long useful life or a stable level of productivity. The units of production method may be more suitable for used assets or expected to generate significant revenues or cost savings based on their usage or productivity.
6. Impact on financial statements: Each of the three methods may have a different impact on a business's financial statements, such as the income statement and the balance sheet. For example, the double declining balance method may result in higher depreciation expenses in the early years of an asset's useful life. In contrast, the straight-line method may result in more evenly distributed depreciation expenses over the asset's useful life. The units of production method may result in fluctuating depreciation expenses depending on the asset's actual usage or productivity.

To summarize, the key differences are:

•  the degree of accelerated depreciation, 
• The complexity of the method, and 
• The accuracy of the method. 

Businesses should consider these factors when choosing the most appropriate depreciation method for their assets. 

Real-World Examples

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:

• A manufacturing company purchases a new production line for $1,000,000. The production line is expected to have a useful life of 10 years and a salvage value of $100,000. Using the Double Declining Balance Method, the company calculates an annual depreciation expense of $160,000 (1,000,000 x 0.2 x 2).
• A retail store purchases a new point-of-sale system for $5,000. The system is expected to have a useful life of 5 years and a salvage value of $500. Using the Double Declining Balance Method, the store calculates an annual depreciation expense of $800 (5,000 x 0.2 x 2).
• A restaurant purchases a new oven for $20,000. The oven is expected to have a useful life of 10 years and a salvage value of $2,000. Using the Double Declining Balance Method, the restaurant calculates an annual depreciation expense of $3,200 (20,000 x 0.2 x 2).

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. US GAAP: Under US GAAP, the double declining balance method is covered by the Financial Accounting Standards Board's (FASB) Accounting Standards Codification (ASC) Topic 360, Property, Plant, and Equipment. According to ASC 360, businesses must use a systematic and rational method of depreciation based on the asset's expected future economic benefits and the pattern in which those benefits are expected to be consumed. The double declining balance method is one of several acceptable methods that can be used to depreciate fixed assets.
2. IFRS: Under IFRS, the double declining balance method is covered by International Accounting Standard (IAS) 16, Property, Plant, and Equipment. According to IAS 16, businesses are required to use a systematic and rational method of depreciation that reflects the expected pattern of consumption of the economic benefits embodied in the asset. The double declining balance method is one of several acceptable methods that can be used to depreciate fixed assets.

US GAAP and IFRS allow the double declining balance method to be a valid depreciation method for fixed assets. Businesses should follow the relevant guidance for their jurisdiction when using this method.

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 IFRS or US GAAP certification course.