This is principlesofaccounting.com, Chapter 10.
And in this module we will look at the double declining balance
method of depreciation, as well as changes in estimates.
And so the double declining balance method is one of several
accelerated depreciation methods.
It results in larger amounts of depreciation in earlier years, and
lesser amounts in later years of asset life.
It's justified if the quality of service produced by an asset declines over time,
or if repair and maintenance costs are expected to rise over time.
Both of those are explanations, or reasons, or justifications for
accelerated methods, although indeed no particular justification is needed.
It's one of several acceptable depreciation methods.
With Double-Declining Balance, we're going to take 200% of the straight line rate,
and multiply that times the remaining book value of the asset at the end of each
period, to determine depreciation for a particular period.
So let's look at an example.
This is the same asset we looked at in a previous module with straight line.
It has a $100,000 cost, a $10,000 salvage value, and a four-year useful life.
So double declining balance would look like this.
First of all, recognize that with a four-year service life,
the straight-line rate is 25% per year.
So twice the straight-line rate or the double declining balance, is 50%.
So we're going to take the initial asset cost of 100,000 times 50%,
to get the first year of depreciation expense of $50,000.
That will cause a reduction in the book value to $50,000,
that is, cost of $100,000- $50,000 of accumulated depreciation
gives us a remaining book value or balance, of $50,000 times
twice the straight-line rate to get year two's depreciation of $25,000.
Each year it'll be reduced correspondingly.
The last year can become a bit problematic.
We would have a remaining $12,500 of net book value going into that year.
And 50% times that would be well in excess of $2500, but
for some reason I'm only showing 2500 as depreciation expense.
And the reason is, we've ignored salvage value to this point in the calculations.
We're going to only take salvage value into account when we depreciate down to or
through the depreciable base.
We had a $90,000 depreciable base, we hit that in the last year, and
we simply cut off at that point, and don't record any more depreciation expense.
So let's review that concept.
Salvage value is initially ignored, with double-declining balance.
But once accumulated depreciation reaches the amount of the depreciable base,
depreciation ceases.
For year four, the calculated amount of depreciation would be $6,250,
that is $100,000 cost minus the previous accumulated depreciation
times 50% would give us $6,250, but that would cause total
accumulated depreciation to exceed the $90,000 depreciable base So
we'll only book $2,500 of depreciation expense in the last year.
If the asset has no salvage value,
the double-declining balance would never fully depreciate the asset.
Usually a company will change to straight-line near the end of the useful
life of an asset, simply to finish off the accounting for the full cost of the asset,
if there is no salvage value.
There are spreadsheet robots for this.
Here's an example where we have the formula DDB, $100,000 cost,
$10,000 salvage value, four-year life, and in the final variable is indicating that
we're in year three of the life The depreciation returned would be $12,500.
Again, here's a pop up box where one could fill in the variables, and
it would return a formula result of $12,500 in this case.
So these spreadsheet deals are very useful, even for
depreciation calculations.
Let's consider fractional period depreciation with double
declining balance.
The first partial year will be a fraction of the annual amount.
All subsequent years will be based on the normal calculation.
In this case, we've got our $100,000 asset times twice our straight line rate,
or 50%.
But we only use the asset for nine months, or 9/12 of the year.
And so we return 37,500 of depreciation for the year.
And that takes us into the next year with a book
value of 100,000 cost minus 37,500 of accumulated depreciation.
We start the year with 62,500 net book value times twice the straight
line rate or 50%, would give us $31,250 as depreciation expense.
Once again, as we near the end of the useful life here,
we can see that we'll simply stop depreciating when accumulated depreciation
reaches the $90,000 depreciable base.
There are alternatives to DDB.
The 150% declining balance method, the 125% declining balance method.
Identical methodologies to what we've just looked at,
except that rather than using the twice the straight line rate, we'll use one and
a half or one and a quarter times the straight line rate.
Finally, let's think about changes in estimates for depreciation.
Assumptions about useful life and depreciable base are merely estimates.
New information may periodically suggest revisions of estimates.
A change in estimate does not require restatements of prior periods' financial
statements.
These changes are handled perspectively over future accounting periods.
So by way of example, let's assume our $100,000 four-year life asset with
$10,000 salvage value has been depreciated for two years.
At the beginning of the third year, new information suggests the asset will have
a total life of seven years, and a $5,000 salvage value.
The revised remaining depreciable base should be
spread over the revised remaining useful life.
And so here's the calculations.
The first year, we took $22,500.
The next year, we took $22,500.
But in year 3, we're changing our estimates.
We're changing from a four-year life to a five-year life.
And we're changing from a $10,000 salvage value to a $5,000 salvage value.
The depreciation already taken is 45,000.
So our cost of 100,000 minus the depreciation already taken, leaves us
55,000 of remaining cost, 5,000 of which will be recovered through salvage value.
And so our calculation, 100,000 cost minus depreciation are already taken,
minus remaining salvage value to spread over the remaining life of 5 years.
And we'll get a $100,000 for Year 3, and boosting our accumulated depreciation
of $55,000, and so it will go for each subsequent year.
In closing this module, I would like to point out issues about asset revaluation.
International financial reporting standards actually include
provisions that permit companies to revalue items of property, plant, and
equipment to fair value at each reporting date.
When applied, all assets in the same class are to be revalued annually.
These adjustments to evaluation are offset with changes in capital accounts.
But they also result in continuous alterations of depreciation amount.
So a depreciation can become far more complex under the international reporting
system that allows for, or permits for revaluation of assets.