Declining Balance Method

What it is

The declining balance method (also called the reducing balance method) is an accelerated depreciation technique that records larger depreciation expenses in an asset’s early years and smaller expenses later. It’s commonly used for assets that lose value quickly or become obsolete—examples include computers, phones, and other technology.

How it works (formula)

Annual depreciation = Current book value × Depreciation rate

• Current book value = Cost − Accumulated depreciation (at the start of the period).
• Depreciation rate is chosen to reflect how rapidly the asset loses value.
• Salvage (residual) value is not multiplied into the formula each year, but depreciation must not reduce book value below the salvage value.

Step-by-step example

Asset: cost $1,000, salvage value $100, depreciation rate 30%.

• Year 1: Depreciation = $1,000 × 30% = $300 → End book value = $700
• Year 2: Depreciation = $700 × 30% = $210 → End book value = $490
• Year 3: Depreciation = $490 × 30% = $147 → End book value = $343

Continue each year until the remaining book value approaches the salvage value; in the final periods, adjust depreciation so book value does not fall below salvage.

Comparison with other methods

• Straight-line: Spreads depreciation evenly. Annual depreciation = (Cost − Salvage) / Useful life. Use this when asset value is consumed uniformly over time.
• Double-declining balance (DDB): An accelerated form that doubles the straight-line rate. For a 5‑year asset, straight-line rate = 20%, DDB rate = 40%. DDB produces faster write‑offs than a single-rate declining balance.

Example (double-declining, $5,000 cost, $500 salvage, 5 years):
– Straight-line rate = 20%; DDB rate = 40%
– Year 1: $5,000 × 40% = $2,000
– Year 2: ($5,000 − $2,000) × 40% = $1,200
– Repeat, adjusting the final year so book value does not drop below salvage.

Accumulated depreciation

Accumulated depreciation is the total depreciation recorded for an asset from when it’s placed in service. It increases each period by the depreciation expense and is used to calculate current book value.

Tax and financial effects

• Accelerated depreciation reduces taxable income more in the early years, deferring tax liability to later periods.
• Net income will be lower in early years, which can affect financial ratios.
• When an asset is sold, the lower book value created by accelerated depreciation can produce a larger reported gain—this may affect how investors perceive a company’s performance.

When to use it

Use declining balance methods when an asset:
– Loses value rapidly or becomes obsolete quickly (e.g., technology).
Avoid it for assets that provide consistent service over time (e.g., buildings, long-lived machinery) where straight-line is more appropriate.

Bottom line

The declining balance method accelerates depreciation to match higher economic or technological obsolescence early in an asset’s life. It’s a useful tool for tax planning and for reflecting real patterns of asset consumption, but it alters reported earnings and can affect comparisons across firms. Choose the method that best matches the asset’s actual usage and your financial reporting objectives.

References

• IRS Publication 946, How to Depreciate Property
• Accounting and finance resources on accumulated depreciation and depreciation methods