Declining balance depreciation is a method of measuring the depreciation value of an asset that is based on the depreciation rate of the asset. It applies the rate of depreciation over the life of the asset until the value reaches the salvage value. This differs from the straight-line method of depreciation, in which the depreciation amount is spread evenly throughout the life of the asset. By contrast, the declining balance depreciation method keeps applying the depreciation rate to the balance of the asset's worth, meaning that the amount of depreciation lessens each year.
Depreciation is the amount by which an asset declines throughout the time it is used. When a business files a tax return, depreciation values of its assets must be considered. For example, a five-year-old computer will not have the same value as a new one. The declining balance depreciation method is often used because companies often calculate the expense an asset when it is new, and thus prefer the expense to decline as the years pass.
For example, imagine that an asset valued at $500 US Dollars (USD) is expected to depreciate at a rate of 50 percent each year. Using declining balance depreciation, that means the value of that asset would depreciate by 50 percent of $500 USD, or $250 USD, throughout the first year, meaning that its year-two value would be $250 USD, or $500 USD minus $250 USD. In year two, the balance of $250 USD would then depreciate by 50 percent, taking away another $125 USD from the value. This process would continue until the value reached the predetermined salvage value of the asset.
Even though it differs from the straight-line method, in which an asset is depreciated the same amount each year, declining balance depreciation is often used in conjunction with this method. This technique produces what is known as double declining balance depreciation. In this method, the straight-line method is used to determine the rate of depreciation, which is then doubled to provide the rate for the declining balance method.
As an example, an asset with a value of $500 USD with a life expectancy of five years would depreciate $100 each year using the straight-line method. This means that the asset depreciates at 20 percent per year, as $100 USD is 20 percent of $500 USD. To use the double declining method, this 20 percent is doubled to produce a depreciation rate of 40 percent. That rate is then plugged into the declining balance method to determine the amount of depreciation each year.