Author: Jim Riley Last updated: Sunday 23 September, 2012
Depreciation - reducing balance example
In our introduction to the methods available to calculate depreciation, we
suggested that there are two main methods that can be used:
- Straight- line depreciation
- Reducing balance method
We emphasised the point that these two methods simply provide an alternative
way of allocating the total depreciation charge over several accounting periods.
The total depreciation charge using either method will be the same over the
total useful economic life of the asset.
To illustrate the reducing balance depreciation method, we have calculated
the depreciation charge for the following asset:
A business purchases a new machine for £75,000 on 1 January 2003. It
is estimated that the machine will have a residual value of £10,000
and a useful economic life of five years. The business decides to calculate
annual depreciation at the rate of 40% of the written-down value. The business
has an accounting year end of 31 December.
Reducing balance depreciation method
Using the straight line depreciation method, the calculation of the annual
depreciation charge is as follows:
Original machine cost
Depreciation in 20X3 (40% cost)
Written down value at 31 December 20X3
Depreciation in 20X4 (40% of WDV @ 31 December 20X3)
Written down value at 31 December 20X4
Depreciation in 20X5 (40% of WDV @ 31 December 20X4)
Written down value at 31 December 20X5
Depreciation in 20X6 (40% of WDV @ 31 December 20X5)
Written down value at 31 December 20X6
Depreciation in 20X7 (40% of WDV @ 31 December 20X6)
Written down value at 31 December 20X7
The reducing balance method can result in significant differences
in the annual depreciation charge, depending on the "percentage"
of written-down value that is used to calculate the charge.
In the example above, the total amount charged to depreciation
in the first three years of owning the machine (20X3-20X5) was £58,800
(compared with £39,000 if a straight line depreciation method has been