The Diminishing Balance Method, also known as the Reducing Balance Method or Written Down Value (WDV) Method, is a method of depreciation under which depreciation is calculated on the remaining book value or written down value of an asset.
Under this method, depreciation is charged on the non-depreciated balance of the asset. Therefore, a higher amount of depreciation is generally charged during the earlier years of the asset’s useful life, while the amount of depreciation gradually decreases in later years.
The Diminishing Balance Method is an accelerated method of depreciation because it results in a greater depreciation charge during the initial years of an asset’s useful life.
Calculation of Depreciation under WDV Method
Under the Written Down Value Method, a fixed rate of depreciation is applied to the book value of the asset at the beginning of each accounting year.
The depreciation expense for a period may be expressed as:
Depreciation Expense = Opening Written Down Value × Depreciation Rate
After charging depreciation, the closing book value is calculated as:
Closing Book Value = Opening Book Value − Depreciation Expense
The closing book value of one year becomes the opening written down value for the next year. The same depreciation rate is then applied to the reduced book value.
Therefore, although the depreciation rate remains constant, the amount of depreciation decreases every year because the value on which the rate is applied continuously decreases.
Example of Diminishing Balance Method
Suppose an asset has an original cost of $1,000, a depreciation rate of 40%, and an estimated scrap value of $100.
In the first year, depreciation is calculated on the original cost of $1,000.
Depreciation = $1,000 × 40% = $400
The closing book value will be:
$1,000 − $400 = $600
In the second year, the same rate of 40% is applied to the reduced book value of $600.
Depreciation = $600 × 40% = $240
The closing book value becomes:
$600 − $240 = $360
The depreciation schedule is as follows:
| Year | Depreciation Rate | Depreciation Expense | Accumulated Depreciation | Book Value at Year-End |
|---|---|---|---|---|
| Original Cost | — | — | — | $1,000.00 |
| 1 | 40% | $400.00 | $400.00 | $600.00 |
| 2 | 40% | $240.00 | $640.00 | $360.00 |
| 3 | 40% | $144.00 | $784.00 | $216.00 |
| 4 | 40% | $86.40 | $870.40 | $129.60 |
| 5 | — | $29.60 | $900.00 | $100.00 |
The example shows that the depreciation expense decreases every year. It falls from $400 in the first year to $240 in the second year, $144 in the third year, and $86.40 in the fourth year.
In the final period, only $29.60 is charged as depreciation because the book value of the asset must not be reduced below its scrap value of $100.
Double-Declining-Balance Method
The Double-Declining-Balance Method is an accelerated form of the reducing balance method. It calculates depreciation at an accelerated rate on the non-depreciated balance of the asset, particularly during the earlier years of the asset’s useful life.
Under this method, a larger portion of the asset’s cost is allocated as depreciation during the initial years. As the written down value of the asset decreases, the depreciation expense also decreases.
The method therefore results in higher depreciation in earlier years and lower depreciation in later years.
Treatment of Salvage Value
Under the Double-Declining-Balance Method, the salvage or residual value is not considered while determining the annual depreciation amount.
However, the book value of the asset must never be reduced below its estimated salvage value.
Therefore, even if the application of the depreciation rate produces a larger depreciation amount, depreciation is restricted so that the closing book value does not fall below the salvage value.
Depreciation stops when the asset reaches its salvage value or the end of its useful life, whichever applicable limit is reached.
Depreciation Rate under Declining Balance Method
Under the Declining Balance Method, a depreciation rate may be calculated that allows the asset to be depreciated to its residual value by the end of its estimated useful life.
The formula is:
Depreciation Rate = 1 − (Residual Value ÷ Cost of Fixed Asset)^(1/N)
Here, N represents the estimated useful life of the asset, normally expressed in years.
The formula determines the rate at which the book value of the asset should decline so that it reaches the expected residual value by the end of the estimated period.
Conversion to Straight Line Method
The Double-Declining-Balance Method may not always fully depreciate an asset to its residual value by the end of its estimated useful life.
Therefore, under certain methods, both the declining balance depreciation and straight-line depreciation are calculated each year. The greater depreciation amount is then applied.
This treatment may result in a change from the Declining Balance Method to the Straight Line Method at a midpoint or suitable stage in the useful life of the asset.
The purpose of this conversion is to ensure a more appropriate allocation of the remaining depreciable amount over the remaining useful life of the asset.
Matching Cost with Benefits from Asset Use
The Double-Declining-Balance Method may better represent the depreciation pattern of certain assets, such as vehicles.
Some assets may lose more value or provide a greater level of economic benefit during the earlier years of their useful lives. Therefore, charging higher depreciation in the earlier years may more accurately match the cost of the asset with the benefits obtained from its use.
As the asset becomes older, its book value decreases and the amount of depreciation charged also becomes lower.
Difference between Straight Line and WDV Method
Under the Straight Line Method, depreciation is calculated by allocating the depreciable cost equally over the useful life of the asset. Therefore, the same amount of depreciation is charged every year.
Under the Written Down Value Method, a fixed depreciation rate is applied to the reducing book value of the asset. Therefore, the depreciation amount is higher in the earlier years and gradually decreases in later years.
Thus, the Straight Line Method provides equal annual depreciation, whereas the WDV Method provides diminishing annual depreciation.
Exam Focus
The Diminishing Balance Method is also known as the Reducing Balance Method or Written Down Value (WDV) Method. Under this method, depreciation is calculated on the opening book value or non-depreciated balance of the asset.
The basic calculation is:
Depreciation Expense = Opening Written Down Value × Depreciation Rate
A fixed depreciation rate is applied every year, but the amount of depreciation decreases because the written down value of the asset decreases each year.
The Double-Declining-Balance Method is an accelerated depreciation method and charges higher depreciation during the earlier years of an asset’s useful life.
Under the Double-Declining-Balance Method, the salvage value is not considered in calculating annual depreciation, but the book value of the asset must never be reduced below the salvage value.
Depreciation ceases when the asset reaches its salvage value or the end of its useful life. In certain cases, depreciation may be changed from the Declining Balance Method to the Straight Line Method during the asset’s useful life.