Farwah Jafri | November 10 2022
Double declining balance depreciation – an easy way to save money with regard to your business expenses.
The double declining balance method helps your asset’s value depreciate less and less over time. This means the biggest taxes are written off after you have purchased a business asset such as equipment, vehicle, tool, or real estate.
Does this sound interesting? Well, read it till the end to learn more about it!
To understand the double declining balance method, it is important to get hold of the concept from the very beginning, therefore let’s start from the very basic and that is understanding what depreciation is.
According to Investopedia, “depreciation is an act in which the asset’s value is written off over its life expectancy of usefulness and is reported on Form 4562 of the IRS.”
The double declining balance method is a way of calculating depreciation and reporting it.
The double declining balance method is often referred to as the accelerated depreciation method. Majority of businesses use this method when their assets are more productive especially in the early years or for those assets which are bound to lose their value rather quickly.
This method is used commonly in two scenarios:
o When the asset is supposed to depreciate at a rapid rate in the initial years of its life.
o The business intends to write off the expense in the early stage of purchase to reduce the profitability in order to defer the taxes.
Double declining balance depreciation is calculated by using this formula:
(Cost of asset/ Length of useful life in years) x 2 x Book value
This formula works for the depreciation amount of an asset every year except for the last year. In the last year, the amount to be depreciated will be the difference between the asset value at the beginning of the year and the salvage value in the final year.
Straight line depreciation method is the basic kind of depreciation. In this method, the depreciation amount remains the same and is deducted from the actual value each year. For instance, if an asset is valued at $1000, and its write-off amount is $100, then it will remain the same for the next 10 years.
On the contrary, in the double declining balance method, a large portion of depreciation expense is written off in the early years of purchase and less each year after that. In this method, the depreciation amount is different every year.
Let’s have a look at some of the advantages and disadvantages of this depreciation method.
Here are some of the advantages of the double declining balance method:
Some of the depreciable assets like vehicles work perfectly when they are bought, but they require more maintenance as time passes by. This maintenance amount is tax-deductible. The double declining depreciation method will let you have a bigger tax written-off in the early years when it is minimal.
Maintenance becomes more in the later years and at that time you will be writing off the less depreciable value of the asset and writing more against maintenance. This simply means that the annual write-off of the depreciation will be more stable with the passage of time making the income easier to predict.
Some assets start yielding you monetarily as soon as you buy them. You are supposed to pay taxes on this income but you can easily reduce this tax obligation by writing off more of the depreciation amount in the early years. As time goes by, less depreciation is deducted from the value of the asset and less income comes therefore the two of them are balanced out.
More money is retrieved with the early write-off taxes that helps in getting back the purchasing cost of the asset in the later years. This also helps if you have taken a loan on the said asset as when you pay a large chunk earlier, it reduces the amount of interest to be paid each year.
Like everything else, the double declining balance method has its own set of cons. Let’s have a look.
This method is not as easy as the straight-line method. It requires crude calculations. The double declining balance method is complicated. If it is your first time filing depreciation through this method then it is advisable to hire an accountant to make sure there are no errors.
You are required to predict your income every year when you file the quarterly taxes. It becomes difficult to predict your income when you use the double-declining balance method. As the writing-off amount is different for each year, you might find yourself crunching over numbers to get the right amount of income predicted.
When you purchase an asset, you should be well aware of its useful life. Some assets last for decades whereas others depreciate rapidly in the initial years. It is up to you to decide which depreciation method you would apply for a certain asset.
In the end, we can conclusively say that the double declining balance method is a more complex method of calculating depreciation as compared to the straight-line method. At the same time, it is very useful when it comes to deferring taxes and maintaining low profitability in the early years of asset purchase.
Farwah is the Product Owner of Monily. She has an MBA from Alliance Manchester Business School, UK. She is passionate about helping businesses overcome challenges that hamper their growth, which is why she is working at Monily to facilitate entrepreneurs to efficiently manage business finances and stay focused on growth.