Income Statement Analysis
Some companies use accelerated depreciation methods to defer their tax liabilities to future years. One such method is the double declining balance method. It was implemented and authorized for the first time under the Internal Revenue Code in 1954, marking a significant change from the existing policy.
This method takes most of the depreciation costs in the early years, reducing profits in the income statement sooner rather than later. The theory suggests that some assets experience most of their use and lose most of their value shortly after acquisition rather than being evenly distributed over a longer time period.
Lower profits result in paying less income tax in those early years.
How to Calculate Double Declining Balance Depreciation
Companies can use one of two versions of the double declining balance method: the 150% version or the 200% version. The 150% version is suitable for properties with a longer useful life.
In this example, we will use the 200% version. Let’s assume you purchased an asset for $100,000, which will have a salvage value of $10,000 at the end of its useful life. This gives you a depreciable base of $90,000. Assume the asset’s useful life is ten years.
Subtract the acquisition cost of the asset of $100,000 from the estimated salvage value of $10,000. You now have $90,000 subject to depreciation. Divide $90,000 by the number of years the asset is expected to remain in service using the straight-line method – ten years in this case. The annual depreciation expense will be $9,000. Convert the assumed depreciation expense of $9,000 into a fraction of the total depreciable amount. That equates to $90,000. You arrive at 0.10 or 10% by taking $9,000 and dividing it by $90,000. Multiply 2 by 10% to arrive at 20%. Then apply the 20% depreciation rate to the current value of the asset at the beginning of each year. It is a common mistake to apply it to the original depreciable amount, but that is incorrect. This process continues until the last year when a special adjustment must be made to complete the depreciation and return the asset to the salvage value.
It is important to note that if you are using the 150% double declining balance method, you would take 1.5 × 10% in step 4.
Using the 200% Double Declining Balance Method
| Year | Applied Rate | Depreciable Base | Current Value at Beginning of Year | Depreciation Expense | Current Value at End of Year |
|---|---|---|---|---|---|
| 1 | 20.00% | $100,000.00 | $20,000.00 | $80,000.00 | |
| 2 | 20.00% | $80,000.00 | $16,000.00 | $64,000.00 | |
| 3 | 20.00% | $64,000.00 | $12,800.00 | $51,200.00 | |
| 4 | 20.00% | $51,200.00 | $10,240.00 | $40,960.00 | |
| 5 | 20.00% | $40,960.00 | $8,192.00 | $32,768.00 | |
| 6 | 20.00% | $32,768.00 | $6,553.60 | $26,214.40 | |
| 7 | 20.00% | $26,214.40 | $5,242.88 | $20,971.52 | |
| 8 | 20.00% | $20,971.52 | $4,194.30 | $16,777.22 | |
| 9 | 20.00% | $16,777.22 | $3,335.44 | $13,421.77 | |
| 10 | 20.00% | $13,421.77 | $2,684.35 + $737.42 special adjustment for last year | $10,000.00 |
The adjustment in the last year was calculated because the current value at the end of the ten-year period would have been $10,737.42, but you know the salvage value was $10,000.00, and this should be the correct final value.
This is the double declining balance depreciation method at 200%.
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Sources:
– U.S. Department of the Treasury. “History of Federal Tax Depreciation Policy.” Page 12.
– State Controller’s Office of Idaho. “Types of Depreciation and Processes.”
– Center for American Progress. “Accelerated Depreciation.”
– Rice University. “11.3 Explanation and Application of Depreciation Methods for Allocating Capital Costs.”
Source: https://www.thebalancemoney.com/double-declining-balance-depreciation-method-357573
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