Depreciation is a way for accountants to record the real value of assets within an organization. When you buy an asset, like a car for example, the value of the car starts out as the purchase price of the car, but as you use the car and as it ages, the value of the car decreases. This decrease in value represents a real cost for an organization because the organization will have to replace the asset at some point, so it’s important to account for the decrease in value. The ChalkTalk: Financial Accounting course will help you to understand basic accounting principles and includes a section on how to adjust entries using the different depreciation methods.
There are various ways to account for depreciation. The straight line method of depreciation calculates the value that the asset decreases by over a given period of time. The straight line method is used to calculate ordinary depreciation. There are however certain assets that depreciate exponentially over a given period. This kind of depreciation is called the double declining balance method of calculating depreciation and it allows you to account for accelerated depreciation.
Double Declining Balance Depreciation
The double declining balance depreciation method is generally used when an asset is depreciating at a faster rate at the beginning of its lifespan or where the organization intends to shift profits further into the future by accounting for larger amounts of depreciation at the beginning of the asset’s life span.
The double declining balance of depreciation is a little more complicated to calculate than the straight line method and it requires that the straight line depreciation rate be calculated first.
The formula for calculating the double depreciation balance can be expressed as follows:
Double Declining Balance Rate × Book value at the beginning of the year.
So to calculate the value, we need to calculate the straight-line depreciation rate of the asset and we need to know the book value of the asset at the beginning of that particular year.
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Let’s examine an example of how to calculate double declining depreciation using the formula given above.
Double Declining Balance Example
We will use the following example to show you how to calculate the double declining balance for a fictitious company called Acme Inc.
Acme Inc. purchased a vehicle for fifty thousand dollars in 2010. The estimated resale value of the vehicle at the end of its lifespan is calculated at ten thousand dollars. The lifespan of the car for depreciation purposes is estimated to be five years. Calculate the depreciation applicable at the end of 2010 using the double declining method of depreciation.
To calculate the depreciation using this method, we need to calculate the straight line depreciation rate first:
Straight line depreciation rate = 1 / Lifespan of the asset
Straight line depreciation rate = 1/5 = 0.2 or 20%
The double declining balance rate = 2 x straight line depreciation rate:
Double declining balance rate = 2 x 20% = 40%
The book value of the vehicle at the beginning of 2010 is $ 50 000.00
The depreciation for the first year in 2010 is therefore:
$50 000 x 40% = $ 20 000
The depreciation cost for the first year of the asset would therefore be $ 20 000 and the new asset value at the beginning of 2011 would be $ 30 000.
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Let’s continue our example and calculate the depreciation for 2011. We have already calculated the depreciation rate as 20% per annum and the double declining balance rate at 40%. The new book value for the vehicle is equal to the purchase price minus the depreciation for the year 2010. So the book value of the vehicle is therefore $ 30 000.
The depreciation for 2011 is therefore:
$ 30 000 x 40% = $ 12 000
The depreciation for 2010 was calculated as $ 20 000. The 2011 depreciation was $ 12 000. So you can see that the depreciation of the vehicle was more in 2010 than it was in 2011. The depreciation therefore represents accelerated depreciation – where the depreciation at the beginning of the asset’s life span is faster than the depreciation towards the end.
Depreciation is an Important Accounting Concept
It is really important to understand how to calculate depreciation because depreciation alters the value of a company’s assets and can therefore affect the company’s current value. The Straight Line Depreciation Method – How to Calculate Depreciation offers a tutorial on how to calculate straight line depreciation.
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