The expired value of assets is treated as depreciation for the purpose of periodic accounting and profit determination; e.g. one machine costs Rs 10,000 and has a useful life of 5 years. Every year the value of this machine will diminish by Rs 2,000 and such reduction in the value is treated as depreciation.
Diminishing Balance Methods (DBM):
Under this method the amount of depreciation is calculated at the prescribed rate of depreciation. The rate of depreciation is decided on the basis of the total depreciable amount to be depreciated on diminishing balance value over the expected life of the asset. The diminishing balance at any point of time is the acquisition cost less that amount of depreciation provided on that asset till that date. It should be noted that the rate of depreciation tends to be substantially higher than the SLM method. Usually the rate is double than that under the SLM, and that is why this method is also described as the double declining balance method. The rate of depreciation is presented on percentage basis and remains fixed but the yearly amount of depreciation diminishes gradually as it is calculated on the diminished value (i.e. acquisition cost less the total accumulated depreciation till the date) of the asset. Under the method the amount of depreciation is higher than the SLM in the initial stages, lower in the later years and bout equal the mid life of the asset.
A machine was purchased on 1st January 1986 at a price of Rs 16,000. The estimated life of the machine is 5 years and the salvage value at the end of the useful life is estimated to be Rs 1,000 Calculate the amount of depreciation for each year till the useful of the machine under the diminishing balance method.
For the simplified solution, the rate of depreciation under the DBM is considered as double the straight line method.
The rate of depreciation under the straight line, method will be ascertained as under:
Percentage rate of depreciation under SLM = 100 / n = 100 / 5 = 20%
where “n” represents life of asset in years.
Now, the rate under DBM method would be double the SLM rate, i.e. 2 x 20% = 40% Under the DBM, the yearly depreciation will be calculated at the stipulated DBM rate on the diminishing balance of the asset as under:
First year (1986):
Depreciation = (Diminished value in the beginning) x (DBM rate of the year)
Rs 16,000 x 40% = Rs 6,400.
It should be noted that the diminished value in the beginning o the first year will be nothing but the acquisition cost, while in the subsequent years will be acquisition cost less total accumulated depreciation.
Second year (1987)
Depreciation = Diminished value x Rate
= R 9,600 x 40% = Rs 3,840
Third year (1988)
Depreciation = Rs 5,760 x 40% = Rs 2,304
Fourth year (1989)
Depreciation = Rs 3,460 x 40% = Rs 1,384
Fifth and last year (1990)
In the last year, the amount is depreciation is not considered on the basis of aforesaid formula (Rs 830.40) but depreciation is the balancing figure required to depreciate the residual balancing figure of the depreciable value in full. In this case, it will be calculated as under:
Diminished value in the beginning of the last year = Rs 2,076
Less: salvage value at the end of the life = Rs 1,000
Balancing diminished value to be written off as,
Depreciation in the last year = Rs 1,076
Thus, instead of Rs 830.40 the amount of the depreciation for the last year would be Rs 1,076/-