Depreciation: Declining Balance

Alright. So let's learn a trickier depreciation method, The double declining balance method. So remember when we're talking about depreciation, we're talking about buying a fixed asset something that we're gonna use for a long time and something that we're probably gonna spend a lot of money on and we want to break up that cost over the useful life of that asset. So we're going to use it for multiple years. What we want that cost to be split up over those years. So whenever we calculate depreciation in regardless of what method we're using, we're gonna focus on three variables here. Okay. The three variables we need to know is the cost. How much did we spend on the asset? Right. And they're generally just going to give you these numbers in every problem. They'll tell you the cost and then they're going to estimate a useful life. And this is how long the company expects the asset to help generate revenue, right? How long are they gonna be able to use this asset? And the residual value, That's how much the company expects the asset to be worth after they're done using it. Right? The residual value after they're done. So remember that these two the useful life and the residual value. These are both estimated. Okay. These have to be estimated by the company. They're not going to be Uh you can't know ahead of time, right? You buy a truck, you can't really know how long the truck's gonna last, you, is it gonna last you five years, 10 years? Who knows? Right? So you have to make your best guess and remember that residual value sometimes called salvage value or scrap value, right? There's different names and different ways to interpret that, that residual value. So we're gonna be focusing on the declining balance method in this video and there's different types of declining balance. But in in your class, we just focus on the double declining balance and that's the most common declining balance method. Okay, so the declining balance method, it's an accelerated depreciation method. So remember, regardless of what method you use, you're gonna take the same amount of depreciation, right? There's gonna be some depreciation base, some amount of of the assets value that you're going to depreciate. So it's just a matter of how you split up that depreciation and that's what the methods are gonna split up differently. So the declining balance, it's gonna accelerate depreciation. And what that means is that it's going to front load it in the first few years we're going to take more depreciation and then in the last few years we'll take less depreciation. Okay, so more depreciation is taken in the early years. And what is what would be the benefit to that? Why do we want to take more depreciation in the early years, remember depreciation is an expense and it's going to lower our income, right? If we have higher expenses, well, higher expenses lead to lower income in the early years. And when we have lower income? Well, that means we pay less taxes. Okay? So the benefit of using this type of method is that it it allows us to pay less taxes. And usually when we when we do depreciation for the I. R. S. Uh for for our tax purposes we're gonna use some sort of accelerated method. Okay. And you deal with that more in later classes. How this deals with with taxes and all that. But for now we're gonna focus on just how we calculate it. Okay, so like I said, we're gonna focus there's different types of declining balance but we're focused on the double declining balance which abbreviated to the D. D. B. Double declining balance method. Okay? So let's go through the steps the steps for calculating double declining balance depreciation. And then we'll do an example. Okay so the first step we want to do is we want to calculate we want to calculate the double declining balance depreciation rate. Okay this isn't the amount of depreciation, this is a rate of the of the value that we're going to depreciate each year. Okay so we're gonna use this same rate every year and this is not the depreciation expense. Right? So before when we had our straight line depreciation. Well we calculated the depreciation expense right away. Okay here we're just calculating a rate And what that is. It's one divided by the useful life. So we're gonna use the useful life here and then we multiply it by by two that multiplying it by two. That's the double declining balance. Okay, That's why we're doing the double declining balance is by multiplying it by two here. If we're saying to do the triple declining balance or something like that, that would be a multiple of three in that case. But we're going to focus on double declining balance and we multiply by two. So this gives us a rate. So let's say that it was a 10 year useful life. Well then it would be one divided by 10 times two. And that that 1/10. Well, that's 0.1 times two. So our our rate would be 20.2. Okay, that would be our double declining balance rate would be 0.2 per year. Okay, so that's just an example there. If if we had a 10 year useful life actually, I'll leave that in there. It's gone now. So All right, so that's how we do our depreciation rate, let's go on to step two and that's pretty easy. Right? We just take our useful life one over the useful life multiply by two. So in step two we multiply what we found in step one, the depreciation rate by the beginning netbook value. So remember this Netbook value. It's going to be decreasing each year. Okay, so the beginning netbook value and the depreciation rate. This is our depreciation expense. Okay, this is the depreciation expense right here. So once we do that, we're gonna calculate the beginning value minus the depreciation expense. This is the new netbook value. And this is important because each year we're gonna be using that new netbook value. That's gonna be the new beginning value that we that we multiply by the depreciation rate. So this will start making sense once we get into an example, but these are the steps that we follow and we're gonna keep repeating this process. Okay? So once we find a depreciation rate and our our beginning value are beginning netbook value, we're just gonna keep multiplying, get the depreciation expense for the next year. Find the new netbook value multiplied by the rate all the way until we get to the final year. Okay, so in the final year this is going to be a plug. This is what we call a plug. Okay, because notice at no point are we using our residual value? We're taking the full value of the asset. And we're gonna start multiplying, we're not taking away the residual value at the beginning. This is an important difference with the double declining balance method. We're not gonna remember with the straight line method, we took out the residual value before we started calculating depreciation expense. In this case we don't do that. What we do is in the final year we're like well how much depreciation do we have to take to get us to our residual value. So we figure that out in the last year and then we're left with are residual value in the last year. Cool. So this sounds a little tricky and this is kind of tricky. This is the trickiest, depreciate depreciation method that you're going to deal with. So why don't we pause here and then we'll do an example where you can follow through how we use these steps in the double declining balance method. Alright, let's do that now.

Alright, so let's try this example. Together on january 1st year one, johnson and johnson and johnson company purchased a delivery truck for $42,000. The company estimated a useful life of five years and a residual value of $2000. What would be the entry to record depreciation when preparing the december 31st year one financial statements and the netbook value on that date. Alright. So what I'm gonna do is I'm gonna go through the entire useful life of the asset so you can see how this double declining balance works throughout the whole useful life. So I've got a little table here. Unfortunately on your test, you're probably not going to get a table with all of these data already to all ready to go for you. You're gonna have to remember how to use the method and calculate. But the benefit is that you're usually not gonna have to calculate an entire useful life like we're gonna do here, I'm doing this. So you can see the whole the whole scope of the double declining balance method. But usually they're just gonna ask you in the first year or the second year what that double declining balance depreciation is gonna be cool. So let's go ahead and get started. Our cost here was 42,000, right? They tell us in the problem we had a cost of 42,000. An estimated residual value of 2000 and an estimated useful life of five years, right? A five year useful life. So with this information we're ready to calculate depreciation, this is all the information you ever need for depreciation problems. So in january january 1st year one we have our beginning netbook value right Are beginning Netbook value is our 42,000 right? Because we've taken no depreciation. So our book value is the 42,000. We take no depreciation expense at this point, there's no accumulated depreciation. So our ending book value is still 42,000. Remember that net book value? That's our cost minus the accumulated depreciation. So by december 31st year one we're gonna start with that 42,000 book value. But now we need to calculate depreciation. So now that we're calculating depreciation with the double declining balance method are step one was to get that depreciation rate right? So our rate will do it up here. The rate Is equal to one divided by the useful life which was five in this case times to write, we're gonna multiply by two because it's the double declining balance method. So 1/5 times two that comes out to 0.4. Right? So sometimes you see it as a percentage and they'll say the rate is 40%. I leave it as a decimal because we're gonna be multiplying and it's just easier to use decimals. So our rate is going to be 0.4 and that's gonna be the same every year. We're always gonna stay to the 0.4 rate. But what we're gonna see changing is that beginning netbook value that we calculate against. So the next step is to calculate our depreciation expense, right? Step two, is to multiply the rate times the beginning net book value. And in the first year it's always easy because it's just the cost times the rate. And what does that give us? 42,000 times 20.4, And that's 16,800. So, notice how much depreciation we're taking in the first year, right? We're taking quite a big chunk of depreciation because we're taking basically 40% of the assets worth. We're taking it as depreciation in the first year. Okay? So if our depreciation expense right there, 16,800 well, we hadn't taken any depreciation before, so it was just zero plus the 16 800. That gives us accumulated depreciation of 16,800. Right? So what's gonna be our ending net book value? What we have to take out that accumulated depreciation. So it's always gonna be like this, right? 42,000 minus the 16,800. So our ending net book value, it's going to be 42,000 minus the accumulated depreciation of 16,800 And it gets us to the 25,200, right? So that's our new book value that we're gonna use in the next year. Okay, so 42,000 minus the accumulated depreciation gets us to our new ending net book value? And that's what we're gonna put right here for the next year. 25,200, right? We took this number 25,200. And we put it in year to let me go ahead and get out of the way, because I see my head peeking into that year too. And our double declining balance rate. Well, it's the same every year, right? We're always gonna use 0.4. We calculated that at the beginning. So 0.4 times are beginning. Net book value is of 25 200 times 2000.4. That's gonna give us our our next year's depreciation 25 200 times 2000.4. That comes out to 10,000 0 80 $10,080 is our depreciation expense in the second year. And remember our entry is always the same for depreciation expense? We're going to debit depreciation expense, and credit accumulated depreciation for the same amount. So now we've accumulated in the first year, we had 16,800 of depreciation plus this year's depreciation of 10,000 and $80. Well, our new accumulated depreciation is 26,000 $880. Right? That is our total accumulated depreciation at this point. So what's gonna be our ending net book value? Well, that's the cost, right? 42,000 minus 8 26,080. And Our Ending Net Book Value is 15,120. Okay, so notice notice how it's a little more complicated here, right? Because we have to keep track of that ending. Net book value and that's gonna be our beginning netbook value in the next period. So 15,120 that is our beginning netbook value. What's gonna be our double declining balance rate? Well, it doesn't change, right? 0.4 again. So 0.4 times that 15 1 20 that gives us depreciation in this year. Year three is gonna be $6048 of depreciation, right? That's 15,000 won 20 times 0.4. So what's our new accumulated depreciation? Well, that's the 26 80 from the previous year, plus our additional depreciation of 6048. And what's that get us to now? Our total accumulated depreciation is 32,928. Pretty complicated stuff here. Right, Well, it's just a bunch of arithmetic. So once you get the pattern going, well, it's not so crazy. So 32,928 and accumulated depreciation. So what does that tell us about our ending? Net book value. We've got our 42,000 in cost minus 32,009, 28. And that gets us to a netbook value of 9072 right? 9072 at the end of year three. And that's gonna be our beginning balance for year 4 9072 are double declining balance rate hasn't changed. And we're gonna multiply the 2 9072 times 90720.4. That gives us our depreciation for the next year. And if you'll notice when you do 9072 times 90720.4, well, we get a decimal. Now we got 3628.8. And this happens a lot with the double declining balance rate. Because you can't expect these numbers to stay pretty forever. Right? So what we're gonna do is we're gonna start rounding, I'm gonna round to the nearest dollar and I'm gonna go 3629 3629 is gonna be our depreciation that year. Just to keep the numbers a little prettier there. And let's find out our new accumulated depreciation. 32,009, 28 plus um 6 3029. And what's that? Give us? 36 3029 plus three nine 32,028. Now our total depreciation is 36,005, 57. All right, So one more step and the worst is behind us. 42,000 let's find our ending net book value here. 42,000 minus our accumulated depreciation of 36,005, 57. That gives us our net book value of 5443. Alright, so now we've reached the final year. Remember in the final year we do something a little different. We're not going to keep doing our our double declining rate. What we want to do in the final year is get to our residual value right? Because once we're done depreciating we should have our residual value left. So we're starting this year with a value of 5,443. Right? But we want to end with a residual value. What was it in the problem? It was $2000. So our depreciation expense in the final year should be some amount that gets us from our beginning netbook value to a value of 2000. So how much depreciation expense would that be? Well we just need to subtract the two right? 5443 minus a value of 2000. Well that means we need to take and I'm gonna do this in a different color. 3000 443 in depreciation to get us to our ending net book value, right? Because now look at our accumulated depreciation, look what happens here? 36,557 plus. And I'll do it in blue, 3443. Well that's going to equal when you add those together. Guess what? 40,000? And remember that? 40,000 is our depreciation base, right? We had 42,000 in cost. Remember depreciation base is always the total amount of depreciation depreciation, you're gonna take 42,000 and cost minus 2000 In residual value. Well that's $40,000 and that's exactly how much depreciation we've taken over the five years. And that's what I meant when I said that in year five, it's a plug, right? We're just plugging in the number that gets us to the correct um residual value at the end. So our net ending net book value is the 42,000 -40000 and accumulated depreciation. And there you have it 2000 as our ending net book value, which is our residual value. So let's say the truck keeps working and now it's year six and we're still using the truck. Well, the beginning netbook value is 2000. How much depreciation are we gonna take? None, right? Because we've already fully depreciated this asset, we've taken all the depreciation we're gonna take, there's no more depreciation to take accumulated depreciation is gonna stay at 40,000, and our net book value is gonna stay equal to that residual value of 2000. Okay, so remember, once you're done depreciating the asset, there's no more depreciation to take. That's it, you leave it at the residual value. Cool. Alright, this is pretty hefty stuff. You might even want to watch that video again just to kind of really sink it in. But if you're ready to go, I've got some practice problems lined up for you for the double declining balance method. Alright, let's try those on the next page

ABC Company purchased a new machine on January 1, Year 1 for $44,000. The company expects the machine to last ten years. The company thinks it could sell the scrap metal from the machine for $4,000 at the end of its useful life. If the company uses the double-declining method for depreciation, what will be the net book value of the machine on December 31, Year 2?

• A. $25,600
• B. $26,400
• C. $28,000
• D. $28,160

DBQ Company purchased a machine on January 1, Year 1 for $60,000. The company estimated a five year useful life and $8,000 residual value. If the company uses the double-declining-balance method for depreciation, what will be the amount of accumulated depreciation on December 31, Year 2?

• A. $33,280
• B. $38,400
• C. $41,600
• D. $48,000

XYZ Company purchased a machine on January 1, 2018 for $120,000. The company estimated a four year useful life and $4,000 residual value. If the company uses the double-declining-balance method for depreciation, what will be the amount of depreciation expense for the year 2021?

• A. $7,500
• B. $11,000
• C. $15,000
• D. None of the above