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. However, there are certain advantages to accelerated depreciation methods.
The two most common accelerated depreciation methods are double-declining balance and the sum of the years' digits. Here's a depreciation guide and overview of the double-declining balance method.
What is the double declining balance method of depreciation?
The double-declining balance method multiplies twice the straight-line method percentage by the beginning book value each period. Because the book value decreases each period, the depreciation expense decreases as well. In the final period, the depreciation expense is simply the difference between the salvage value and the book value.
The double-declining balance method accelerates the depreciation taken at the beginning of an asset's useful life. Because of this, it more accurately reflects the true value of an asset that loses value quickly. When you drive a brand-new vehicle off the lot at the dealership, its value decreases considerably in the first few years. Toward the end of its useful life, the vehicle loses a smaller percentage of its value every year.
How to calculate double declining balance depreciation
For example, assume your business purchases a delivery vehicle for $25,000. Vehicles fall under the five-year property class according to the Internal Revenue Service (IRS). The straight-line depreciation percentage is, therefore, 20%—one-fifth of the difference between the purchase price and the salvage value of the vehicle each year.
You estimate its salvage value at $2,000. Under straight-line depreciation, the depreciation expense would be $4,600 annually—$25,000 minus $2,000 x 20%.
The calculation for the double-declining balance method is:
2 x straight-line depreciation percentage x beginning book value = annual depreciation expense
Under the double declining balance method, the annual depreciation would be calculated as follows:
Calculating expensesfrom beginning book value to depreciation
- First year: $25,000—2 x 20% x $25,000 = $10,000
- Second year: $15,000—2 x 20% x $15,000 = $6,000
- Third year: $9,000—2 x 20% x 9,000 = $3,600
- Fourth year: $5,400—2 x 20% x $5,400 = $2,160
- Fifth year: $3,240—$3,240 - $2,000 = $1,240
Double declining balance vs. straight-line
Straight-line stays constant each period. You calculate it based on the difference between your cost basis in the asset—purchase price plus extras like sales tax, shipping and handling charges, and installation costs—and its salvage value. The salvage value is what you expect to receive when you dispose of the asset at the end of its useful life.
On the other hand, a double-declining balance decreases over time because you calculate it off the beginning book value of each period. It does not take salvage value into consideration until you reach the final depreciation period.
If you compare double declining balance to straight-line depreciation, the double-declining balance method allows you a larger depreciation expense in the earlier years. Take the example above. Using the double-declining balance method calculates $10,000 and $6,000 in depreciation expense in years one and two. This is greater than the $4,600 in depreciation expense annually under straight-line depreciation.
So, is the double-declining balance right for your business? A double declining balance is useful for assets, such as vehicles, where there is a greater loss in value upfront. Additionally, it more quickly provides your business with a greater depreciation deduction on your taxes.
However, it's not as easy to calculate, and you must refigure your depreciation expense each period.
It is uncommon, but if you have an expectation of having a higher net profit in the first few years of business, it might make sense to use a method that allows you to take larger depreciation as an expense in the current year.
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