Accounting for Long-term Assets
8.2.2 Double-declining balance method of depreciation
It is well known that any computer value declines with time. A computer may be considered "obsolete" in one or two years after acquisition. So, it is appropriate to assume that a computer will be used more extensively during the first few years of operation. In such situations, to calculate depreciation expense, a double-declining depreciation method may be more appropriate to apply.
Double-declining method is used to record higher depreciation expense in the earlier stages of an asset's life and respectively lower depreciation expense as the asset ages. This method is sometimes called accelerated depreciation method.
Double-declining method applies a constant rate (double of the straight-line rate) to the net book value of the asset and produces a decreasing annual depreciation expense over the asset useful life. The decrease in depreciation relates to the decrease in the asset's net book value in each subsequent period.
To determine depreciation expense under double-declining method, accountants do the following:
- Calculate the straight-line rate. It is calculated by dividing 100% by the number of years the asset is expected to be in use. So, in Mr. Serfy's example, the rate is 25% (100% / 4 years).
- Determine the double-declining balance rate by multiplying the straight-line rate by two: 25% x 2 = 50%.
- Apply the double-declining balance rate to the book (carrying) value of the asset at the beginning of each period.
The table below depicts the depreciation expense computations under double-declining balance method:
Illustration 8-9: Schedule of double-declining depreciation for Mr. Serfy's computer
| Year |
Book
Value |
x |
Double
the |
= |
Annual |
|
| 20X7 |
(23,000 - 0) |
x |
50% |
= |
$11,500 |
|
| 20X8 |
(23,000 - 11,500) |
x |
50% |
= |
$5,750 |
|
| 20X9 |
(23,000 - 17,250) |
x |
50% |
= |
$2,875 |
2,750 |
| 20X0 |
(23,000 - 20,000) |
x |
50% |
= |
$1,500 |
0 |
Note that the book value of an asset cannot be depreciated below its salvage value. The computer historical cost is $23,000 and the salvage value is $3,000, so the amount to be depreciated is $20,000. Because $17,250 ( $11,500 + $5,750) is depreciated after two periods 20X7 and 20X8, only $2,750 more ($20,000 - $17,250) can be depreciated. Accordingly, the $2,875 is ignored in the third year because it exceeds $2,750 limit. Basing on the aforementioned considerations, the $1,500 is also ignored in the fourth year. Observe that the depreciation expense amounts diminished as the computer aged.
Let us assume in this example that the revenue also changes during the 4-year useful life and amounts to $15,500 in 20X7, $9,750 in 20X8, $6,750 in 20X9, and $4,000 in 20X0. Financial statements for those periods are presented below.
Illustration 8-10: Financial statements under the double-declining depreciation method
| Financial Statements under Double-declining Balance Depreciation Method |
||||
| Income Statement |
||||
|
|
20X7 |
20X8 |
20X9 |
20X0 |
| Revenue |
$15,500 |
$9,750 |
$6,750 |
$4,000 |
| Depreciation Expense |
(11,500) |
(5,750) |
(2,750) |
0 |
| Operating Income |
$4,000 |
$4,000 |
$4,000 |
$4,000 |
| Gain |
0 |
0 |
0 |
1,000 |
| Net Income |
$4,000 |
$4,000 |
$4,000 |
$5,000 |
| Balance Sheet |
||||
| Assets |
|
|
|
|
| Cash |
$17,500 |
$27,250 |
$34,000 |
$42,000 |
| Computer |
$23,000 |
$23,000 |
$23,000 |
0 |
| Accumulated Depreciation |
(11,500) |
(17,250) |
(20,000) |
0 |
| Total Assets |
$29,000 |
$33,000 |
$37,000 |
$42,000 |
| Equity |
|
|
|
|
| Contributed Capital |
$25,000 |
$25,000 |
$25,000 |
$25,000 |
| Retained Earnings |
4,000 |
8,000 |
12,000 |
17,000 |
| Total Equity |
$29,000 |
$33,000 |
$37,000 |
$42,000 |
| Statement of Cash Flows |
||||
| Operating Activities |
|
|
|
|
| Inflow from Clients |
$15,500 |
$9,750 |
$6,750 |
$4,000 |
| Investing Activities |
|
|
|
|
| Outflow to Purchase Computer |
(23,000) |
$ 0 |
$ 0 |
$ 0 |
| Inflow from Sale of Computer |
0 |
0 |
0 |
4,000 |
| Financing Activities |
|
|
|
|
| Inflow from Capital Acquisition |
$25,000 |
0 |
0 |
0 |
| Net Change in Cash |
$17,500 |
$9,750 |
$6,750 |
$8,000 |
| Beginning Cash Balance |
$ 0 |
$17,500 |
$27,250 |
$34,000 |
| Ending Balance |
$17,500 |
$27,250 |
$34,000 |
$42,000 |
Page 5 of 9
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