Reducing balance depreciation - What is reducing balance depreciation?
Reducing balance depreciation – also known as declining balance depreciation – is a method of calculating depreciation whereby an asset is expensed as a set percentage.
Debitoor invoicing software uses straight-line depreciation to help small businesses anf freelancers track the value of their assets. Try Debitoor free for 7 days.
The reducing balance method of depreciation results in declining depreciation charges each accounting period. In other words, more depreciation is charged at the beginning of the asset’s lifetime and less is charged towards the end.
This can be useful when an asset has higher utility or productivity when it is new. For example, computers have better functionality and productivity at the start of their useful lives, therefore generating more revenue compared to the later years of their lives. Reducing balance depreciation ensures that higher depreciation is charged when the computer is new to reflect this higher level of productivity and functionality.
How to calculate reducing balance depreciation
To calculate reducing balance depreciation, you will need to know:
- Asset cost – the original value of the asset and any additional costs to get the asset ready for its intended use.
- Residual value – also known as salvage value, this is the value of the asset once it reaches the end of its useful life.
- Depreciation factor –this correlated to the percentage the asset will depreciate by each year. For example, 2 is 200%, 0.5 is 50%.
Once you have this information, you should follow two steps:
Step 1: Calculate the depreciation charge by using the following formula:
Depreciation charge per year = (book value – residual value) x depreciation factor
Step 2: Subtract the depreciation charge from the current book value to calculate the remaining book value.
These steps should be repeated annually throughout the asset's useful life.
Example of reducing balance depreciation
A company purchases a van for £5,000 The company estimates that the van will lose 40% of its value each year, with a scrap value of £1,000. The first five years of calculations would look like this:
Reducing balance depreciation vs straight-line depreciation
An alternative depreciation method is straight-line depreciation. Whereas the reducing balance method charges depreciation as a percentage of an asset’s book value, the straight-line method expenses the same amount each year.
Unlike the reducing balance method, straight-line depreciation cannot account for higher levels of productivity and functionality at the beginning of an asset’s life. However, for most small businesses, it is sufficient – and much more straight-forward – to use the straight-line method.
Depreciation in Debitoor
With Debitoor invoicing software, depreciation is calculated automatically. Whenever you enter a new expense, you’ll be given the option of marking it as an asset. Simply enter the asset’s useful lifespan and estimated residual value, and let Debitoor do the rest!