Depreciation - Reducing Balance

Author: Jim Riley  Last updated: Sunday 23 September, 2012

Depreciation - reducing balance example

Introduction

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:

Data

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:

 31 December £ Original machine cost 75,000 20X3 Depreciation in 20X3 (40% cost) 30,000 Written down value at 31 December 20X3 45,000 20X4 Depreciation in 20X4 (40% of WDV @ 31 December 20X3) 18,000 Written down value at 31 December 20X4 27,000 20X5 Depreciation in 20X5 (40% of WDV @ 31 December 20X4) 10,800 Written down value at 31 December 20X5 16,200 20X6 Depreciation in 20X6 (40% of WDV @ 31 December 20X5) 6,480 Written down value at 31 December 20X6 9,720 20X7 Depreciation in 20X7 (40% of WDV @ 31 December 20X6) 3,888 Written down value at 31 December 20X7 5,832

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 used).

To compare the reducing balance method with the "straight line" method, we have provided a worked example using the same data in the following revision note.

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