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Declining Balance Method

Candlefocus Editor

Declining balance method is a popular accelerated depreciation system used to calculate the deprecation of an asset over its useful life. This depreciation method works by initially computing the depreciation for the first accounting period using the straight-line method, and then using the same rate to calculate the depreciation for the subsequent periods. However, instead of applying the depreciation rate to the remaining cost basis every single period, the depreciation rate is applied to the un-depreciated balance remaining at the end of the previous period. This results in higher depreciation amounts being charged against the asset during the earlier periods of its life, while smaller depreciation amounts are being charged during the later periods of its life.

The key benefit of the declining balance method is the accelerated depreciation that is recorded during the initial years of the asset’s life. By “front loading” the depreciation this way, a business may be able to lower its reported taxable income and thus reduce its overall tax burden. This method is particularly useful for businesses that rely heavily on high technology products, such as computers and cell phones, given the rapid rate of obsolescence in these markets.

The downside of the declining balance method is its inappropriateness for assets that have longer useful lives. Take for example a building that is expected to last for 30 years--it doesn’t make sense to charge a large amount of depreciation expense during the earlier years, as the asset is still relatively “young” from a useful-life standpoint. For such assets, the straight-line depreciation method is the preferred choice.

Overall, the declining balance method is a useful way to calculate depreciation, and it can be tailored to fit the needs of a business, depending upon the rate of depreciation chosen (based on the mid-month convention or double-declining balance). As acceleration of depreciation can produce a short-term tax benefit, businesses should evaluate all options to determine the best choice.

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