Declining Balance Method: What It Is and Depreciation Formula

What Is the Declining Balance Method?

The declining balance method is an accelerated depreciation system of recording larger depreciation expenses during the earlier years of an asset’s useful life. The system records smaller depreciation expenses during the asset's later years.

How to Calculate Declining Balance Depreciation

Depreciation under the declining balance method is calculated with this formula:

$\begin{aligned} &\text{Declining Balance Depreciation} = CBV \times DR\\ &\textbf{where:}\\ &CBV=\text{current book value}\\ &DR=\text{depreciation rate (\%)}\\ \end{aligned}$​Declining Balance Depreciation=CBV×DRwhere:CBV=current book valueDR=depreciation rate (%)​

Current book value is the asset's net value at the start of an accounting period. It's calculated by deducting the accumulated depreciation from the cost of the fixed asset.

Residual value is the estimated salvage value at the end of the useful life of the asset.

The rate of depreciation is defined according to the estimated pattern of an asset's use over its useful life. The expense would be $270 in the first year, $189 in the second year, and $132 in the third year if an asset costing $1,000 with a salvage value of $100 and a 10-year life depreciates at 30% each year.

What Does the Declining Balance Method Tell You?

The declining balance method is also known as the reducing balance method. It's ideal for assets that quickly lose their value or inevitably become obsolete. This is classically true with computer equipment, cell phones, and other high-tech items that are generally useful earlier on but become less so as new models are brought to market. An accelerated method of depreciation ultimately factors in the phase-out of these assets.

The declining balance technique represents the opposite of the straight-line depreciation method which is more suitable for assets whose book value drops at a steady rate throughout their useful lives.

The straight-line depreciation method simply subtracts the salvage value from the cost of the asset and this is then divided by the useful life of the asset. The annual straight-line depreciation expense would be $2,000 ($15,000 minus $5,000 divided by five) if a company shells out $15,000 for a truck with a $5,000 salvage value and a useful life of five years.

Declining Depreciation vs. the Double-Declining Method

It may signal that a company is using accelerated depreciation methods such as the double-declining balance depreciation method if it often recognizes large gains on sales of its assets, Net income will be lower for many years but this ultimately leads to a bigger gain when the asset is sold because book value ends up being lower than market value. Its sale could portray a misleading picture of the company's underlying health if the asset is still valuable.

The Bottom Line

A declining balance method accelerates depreciation so more of an asset’s value can be recorded earlier in its useful life. The flip side is that less of its value can be claimed in its later years. This method is most suitable for assets and equipment that can be expected to become useless and obsolete within a few years such as technology products.

All methods of depreciation can affect a business’s tax picture and taxes owed.