Delining Balance Depreciation Method


Reducing Balance Method charges depreciation at a higher rate in the earlier years of an asset. The amount of depreciation reduces as the life of the asset progresses. Depreciation under reducing balance method may be calculated as follows:

Depreciation per annum = (Net Book Value - Residual Value) x Rate%

Where:

  • Net Book Value is the asset's net value at the start of an accounting period. It is calculated by deducting the accumulated (total) depreciation from the cost of the fixed asset.
  • Residual Value is the estimated scrap value at the end of the useful life of the asset. As the residual value is expected to be recovered at the end of an asset's useful life, there is no need to charge the portion of cost equaling the residual value.
  • Rate of depreciation is defined according to the estimated pattern of an asset's use over its life term.

Example:

An asset has a useful life of 3 years.

Cost of the asset is $2,000.

Residual Value is $500.

Rate of depreciation is 50%.

Depreciation expense for the three years will be as follows:

NBVR.VRateDepreciationAccumalated Depreciation
Year1:(2000-500)x50%=750750
Year2:(1250-500)x50%=3751125
Year3:(875-500)x50%=375*1500

*Under reducing balance method, depreciation for the last year of the asset's useful life is the difference between net book value at the start of the period and the estimated residual value. This is to ensure that depreciation is charged in full.

As you can see from the above example, depreciation expense under reducing balance method progressively declines over the asset's useful life.

Reducing Balance Method is appropriate where an asset has a higher utility in the earlier years of its life. Computer equipment for instance has better functionality in its early years. Computer equipment also becomes obsolete in a span of few years due to technological developments. Using reducing balance method to depreciate computer equipment would ensure that higher depreciation is charged in the earlier years of its operation.

Test Your Understanding

Which of the following is true regarding Reducing Balance Method of depreciation?

It results in higher reported profits in the early years of an asset's life.

It is a more suitable method for depreciating assets that generate higher economic benefits later in their useful life.

It must be applied where an asset is expected to face technological obsolescence relatively quickly.