Double declining balance depreciation

How does the double declining balance method work for calculating depreciation?
Let’s go through some examples, step by step, to make the double declining balance method come alive.
Let’s work with:
A capitalized value, or purchase cost, of $100,000.
A residual value, also known as salvage value, scrap value, or trade-in value, of $7,776. That sounds like a strange amount to use, I will explain you why, once we have made our depreciation calculations.
And finally, an estimated useful life of 5 years.
Based on these parameters, the amount to be depreciated is $92,224, which is the difference between the capitalized value and the residual value.

⏱️TIMESTAMPS⏱️
00:00 Double declining balance method
01:41 Straight line depreciation table
03:04 Double declining balance depreciation table
04:44 Double declining balance formula
06:21 DDB function in Excel
07:04 Double declining balance calculation
09:14 VDB formula in Excel
10:33 Using double declining balance

In the straight line depreciation method, you use a depreciation rate of 20% in this case, which is simply 1 (or 100%) divided by the number of years, which is 5. One fifth per year, 0.2, or 20%. In the straight line method, this depreciation rate is applied to the amount to be depreciated, in the row above, in order to calculate depreciation expense.

In the double declining balance method, you depreciate at double the speed. Two times 20% is 40%. You apply this depreciation rate to the book value of the asset, not to the total amount to be depreciated. As the book value is declining every year, depreciation expense is also declining.

Let’s see what that looks like. Straight line depreciation on the left, double declining balance depreciation on the right. For both of these methods, I have composed a table consisting of the year number, the opening book value for that year, the depreciation expense, accumulated depreciation, and the closing book value for the year.

Straight line depreciation is beautiful in its simplicity. The opening book value is equal to the capitalized value. Depreciation expense is the same amount every year: the amount to be depreciated multiplied by the depreciation rate. Accumulated depreciation is the sum of the history-to-date depreciation, which in year 1 is equal to just the depreciation expense of year 1. For year 4, the accumulated depreciation is equal to the sum of the depreciation expense in years one through four. The closing book value for the year equals the opening book value minus the depreciation expense of that year. The opening book value for year 2 equals the closing book value for year 1. You keep going this way every year: the same amount of depreciation expense, accumulated depreciation going up over the years, and book value going down until you reach the residual value at the end of the last year.

In the double declining balance method, depreciation expense is calculated at double the rate of straight line depreciation, but applied to the book value of the asset. In year 1, 40% of $100,000, which is $40,000. In year 2, 40% of $60,000, which is $24,000. In year 3, 40% of $36,000, which is $14,400. And on and on. Same percentage every year, but applied to a declining balance of book value. When using the straight line method, depreciation expense is the same every year, which is very appropriate if you depreciate a machine that produces the same number of units every year. When using the double declining balance method, depreciation expense is much higher in earlier years than in later years, which is appropriate for assets that are more productive in their early years, and/or assets that lose value quickly, such as vehicles. The other big advantage of the double declining balance method is that #depreciation expense is tax deductible, so most people would say: the more I can depreciate as soon as possible, the better off I am!

So why am I using such a strange number of $7,776 in residual value? Because that’s the only residual value in this specific example where you can use a simple double declining balance calculation. It gets more complicated when the residual value is higher, or lower.

Philip de Vroe (The Finance Storyteller) aims to make #accounting , finance and investing enjoyable and easier to understand. Learn the business and accounting vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better investing decisions. Philip delivers #financetraining in various formats: YouTube videos, livestreams, classroom sessions, and webinars. Connect with me through Linked In!

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