Declining Balance Method

Finance a la shmoop what is double-declining balance sheet

depreciation kind of sounds like that strange-looking British double-decker [Buses in London]

bus right but it's not instead it's a structure or formula under which [Definition of a double declining balance sheet]

companies assess the depreciating value of an asset that you know loses value

it's basically the way they lose or track the loss of value in it that's [Guy talking on a London street]

different from normal depreciation like a tractor smelting Factory or the break [A bucket of molten metal being poured]

room vending machine which used to deposit KitKat bars but has been hanging [KitKat bar gets stuck in the machine]

on to that one bar since 1992 we got to depreciate those well if Shmaterpiller

has a smelting Factory they paid a hundred million bucks to build which [100 million bucks price tag appears]

will be sold for salvage value or scrap for ten million bucks in 20 years then

the decline in total value over that time will be ninety million bucks yep [Decline in value calculation]

over twenty years or four and a half million dollars each year if the company

used straight-line depreciation to account for the loss in value of that [Straight line on a value/time graph]

smelting Factory but under double declining balance depreciation systems

the deduction rate is essentially double the straight-line amounts it's still the

same total amount of deduction it's not like the value of the tractor factory

changed either at purchase time or scrap time but the speed and timing of the [Timeline of depreciation]

depreciation changed to favor high depreciation in the early years giving

the company lower profits but also lower taxes [The first 5 years on the timeline are highlighted]

well the accounting rationale follows suit the utility or value of the asset

is in fact not declining in true market value in a steady state straight-line [Stop sign appears over the value graph]

over twenty years try to convince a buyer that your car

has depreciated only five percent in value a year after you bought it new [Car for sale on eBay]

yeah not happening depreciate way more than that so in double declining balance

depreciation instead of deducting four-and-a-half million bucks a year the

company would deduct nine million a year each year with some adjustments along

the way and yes we're way over generalizing on that statement until [Overgeneralizing flashing red]

that smelting Factory was fully deducted away to whatever terminal salvage value

or scrap value they predicted it would then sell [Factory value declining]

for that is if a normal depreciation was taking four-and-a-half million bucks a

year for 20 years or four-and-a-half percent of the total initial cost then [Straight line depreciation per year]

double declining balance depreciation would take double that number or nine

percent of the hundred million dollars in year one

so they deduct nine million right upfront and your one right goes from 100

to ninety one on the sheets and in reality that's probably a lot closer to [Price tag decreasing]

what the actual loss and market value of the smelting machine and would look like

all right well then in year two double declining balance depreciation would

again take double the flat rate of that four inhabitant they double it to nine

percent of the remaining book value of the smelter or nine percent of the

remaining 91 million that it's worth or about 8.2 million in incremental [Double declining balance depreciation per year]

depreciation for that year leaving the value ninety one - 8.2 or eighty two

point eight million dollars in year three the value of the shelter would

drop another nine percent to about seventy five point four million say we

did all the math therefore there no extra charge and in year four down nine [Post it note showing the calculation]

percent again to around sixty eight point six million dollars so up to this

point the set of deductions would look like this there we go all that stuff you [Amount depreciated in the first 4 years is shown]

notice that as we've gone along here we've taken the beginning of the year

book value of the smelter as the starting point against which to take our

nine percent deduction if we take nine percent always well we'll never get to

zero or rather to the scrap value target there of ten million bucks right nine [The value in the 20th year is shown]

percent and keep just being a tiny tiny amount on those out years so in practice

at some point when companies have depreciated the crap out of their

capital assets well then they switch to straight-line depreciation in this case

after say year five our smelter would be valued at sixty two point four million

dollars ish with fifty two point four million left to depreciate to hit that

ten million dollar scrap value for about three point five million a year for the [Calculation of loss per year is shown]

remaining fifteen years until finally yes Bessie is a put out to pasture the [The factory is thrown into the trash]

gist of double declining balance sheets appreciation is to let companies pay

less in taxes early in their history having more cash to

build their businesses and grow faster at the price of showing lower accounting

earnings and that's just okay with Wall Street so yeah here's to hoping they [Someone doing an okay sign next the Wall St. sign]

deploy that cash into after know something a little more fun [Money going down a water slide]