Why businesses should use Double Declining Balance method?
Imagine Sarah, a small business owner, standing in her busy coffee shop looking at the shiny new espresso machine she just installed. While important for her business, this machine will lose its value over time.
The double declining balance approach will help her with this. It is a valuable tool in accounting to quickly track the decreasing value of the machine in its initial years. This reduces her tax burden and ensures that her books accurately reflect the equipment's depreciation. Many entrepreneurs, like Sarah, can use this method to increase financial health and strategic planning.
Here's everything you need to know about the double-declining balance method of depreciation.
What is depreciation?
Depreciation is an accounting process that involves spreading out the cost of an asset over its lifespan. Essentially, it tracks the gradual decrease in the value of an asset as time passes. Companies include depreciation in their financial reports and tax filings to ensure that the expenses of using an asset align with its diminishing worth over time.
Let's talk about two popular methods for depreciating assets: the straight-line method and the double-declining balance method. The Straight-Line Method is commonly used because it's simple to calculate - the depreciation amount remains constant every year. But this approach has a flaw, as assets don't depreciate consistently each year. On the other hand, with the double-declining balance method, depreciation is higher in the beginning and decreases over time as the asset ages.
The straight-line method calculates depreciation based on the asset's purchase value, while the double-declining balance method uses the asset's book value, which changes annually. The former is more traditional, while the latter provides a more realistic view of asset depreciation.
Also read: Form 1120
What Is the double-declining balance method of depreciation?
The double-declining balance depreciation (DDB) method, also referred to as the reducing balance method, is a popular approach businesses use to track the cost of a long-lasting asset.
The double-declining balance approach speeds up the depreciation of an asset, causing it to lose value more quickly than alternative methods. It is more efficient as it mirrors the decrease in an asset's value resulting from technological advancements. In contrast to traditional methods that rely on past values for depreciation calculations, this method determines depreciation based on the present worth of the asset.
Depreciation = 2×SLDP×BV
Where:
SLDP = Straight-line depreciation percent
BV = Book value at the beginning of the period
Example of double-declining balance
Let's say a company purchases equipment for $10,000, with an expected lifespan of 5 years and a salvage value of $2,000.
Using the straight-line method, the annual depreciation would be $1,600 (($10,000 - $2,000) / 5).
To apply the double-declining balance method, Calculate the straight-line depreciation rate as 1/5 = 20%. Double this rate to get 40%.
The depreciation for each year will be Year 1: 40% of $10,000 = $4,000. Year 2: 40% of $6,000 ($10,000 - $4,000) = $2,400. Continue decreasing by 40% annually until reaching the salvage value.
Advantages and disadvantages of double-declining balance
When to use the DDB depreciation method?
DDB is particularly suited for assets that depreciate rapidly or become outdated quickly. This is often the case with technology such as computers, mobile devices, vehicles, and high-tech equipment., which are valuable initially but lose their usefulness as newer models enter the market.
When considering DDB depreciation, it's important to note that its benefits may not align with every business owner's goals. Opting for this method means spreading tax advantages over a product's useful life, which can be less favourable for businesses aiming to increase immediate write-offs.
This approach suits businesses in the early stages or those frequently upgrading equipment. If you anticipate selling an asset before its full depreciation, DDB might lead to higher tax liabilities. In such cases, exploring alternative methods is wise. While DDB isn't the simplest choice, modern accounting software can simplify tracking asset values during depreciation. However, manual calculations may still be necessary based on your chosen method and software capabilities.
Points to note:
- When it comes to depreciation, there will always be some leftover amount because it's based on a percentage of the asset's book value. Eventually, you'll need to switch to the straight-line method to fully depreciate the asset.
- Once you've written off the entire value, make sure to record the salvage value and close the account.
- Switching accounting methods is bound to happen at some point. Make sure to talk to your accountant about how they figure out depreciation values for various assets.
Also read: Due Dates for Corporate Taxes in 2024
Conclusion
Depreciation helps you understand the value of your business assets and how it decreases over time. The learning curve can be complex, so having accounting software to manage these details helps you focus on your other business activities.
Let Inkle Books take care of your bookkeeping.
Keep track of your assets and their depreciation over time while our tool handles the details for you. Breathe and focus on other important aspects of your business without worrying about complex learning curves. Easily manage transactions and accounts, generate financial reports, and monitor monthly bookkeeping records for better financial control. Trust Inkle Books to take care of your bookkeeping needs.
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