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1.0 INTRODUCTION .................................................................................................................................. 2 1.1 TERMS OF REFERENCE ................................................................................................................. 2 1.2 PROCEDURE ..................................................................................................................................... 2 2.0 MAIN BODY.......................................................................................................................................... 2 2.1 DEPRECIATION ............................................................................................................................... 2 2.2 THE DECLINING BALANCE METHOD OF DEPRECIATION .................................................... 2 2.2.1 TERMINOLOGIES ..................................................................................................................... 3 2.2.2 The double declining balance method.......................................................................................... 3 2.2.3 The Single declining balance method .......................................................................................... 3 3.0 HOW THE DECLINING BALANCE METHOD OF DEPRECIATION IS APPLIED ........................ 3 3.1 Application procedure ......................................................................................................................... 4 4.0 PURPOSE OF THE DECLINING BALANCE METHOD OF DEPRECIATION................................ 4 5.0 CALCULATIONS .................................................................................................................................. 4 5.1 [Example 1], Double declining balance depreciation ......................................................................... 4 5.2 [Example 2] single declining balance method .................................................................................... 5 5.3 Advantages of the Declining balance method of depreciation............................................................ 6 5.4 Disadvantages of the Declining balance method of depreciation ....................................................... 6 6.0 CONCLUSION ....................................................................................................................................... 7 7.0 RECOMMENDATIONS ........................................................................................................................ 7 8.0 REFERENCES ....................................................................................................................................... 8
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1.2 PROCEDURE The information contained in this report was collected through the following means: interviews and literature review. 2.0 MAIN BODY 2.1 DEPRECIATION Depreciation as defined by Bernstein L. A, (1990) is the reduction in value of an asset. He further added that the method used to depreciate an asset is a way to account for the decreasing value of the asset to the owner and to represent the diminishing value of the capital funds invested in it. The common methods of calculating depreciation include; Straight Line Method, Declining Balance Depreciation Method, Sum of Integers Depreciation and Sinking Fund Depreciation. 2.2 THE DECLINING BALANCE METHOD OF DEPRECIATION Declining balance depreciation method (or Reducing balance method or Diminishing balance method) is the accelerated method used in financial reporting to calculate depreciation provision annually. The method is unique in that it utilizes the book value of the asset (original cost accumulated depreciation) instead of the depreciation base (original cost salvage value). This method corresponds to the thought that as the productivity of the asset is at the pick in the starting years and decreases with the passage of time. Thus the depreciation expense for the starting years should be high and then reduces in line with the declining productivity. Declining balance method of depreciation has been classified into two types. These are; Double declining balance and Single Declining balance (Newnan and Lavelle, 1998). The formula for annual depreciation is as follows: Annual Depreciation = Book Value of Asset * Specified Depreciation Rate
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4.0 PURPOSE OF THE DECLINING BALANCE METHOD OF DEPRECIATION It is frequently used for book depreciation purposes. It is used for discounting the value of equipment as it ages ( Kieso et al, 1995). 5.0 CALCULATIONS Note; in double declining depreciation method, the most common rate used is double the straight-line rate. Depreciation rate for double declining balance method = Straight line depreciation rate x 200% 5.1 [Example 1], Double declining balance depreciation On April 1, 2011, Company A purchased equipment at the cost of $140,000. This equipment is estimated to have 5 year useful life. At the end of the 5th year, the salvage value (residual value) will be $20,000. Company A recognizes depreciation to the nearest whole month. Calculate the depreciation expenses for 2011, 2012 and 2013 using double declining balance depreciation method. Useful life = 5 years Straight line depreciation rate = 1/5 = 20% per year Depreciation rate for double declining balance method is then doubled 20% x 200% = 40% per year or
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(*1) $140,000 x 40% x 9/12 = $42,000 (*2) $98,000 x 40% x 12/12 = $39,200 (*3) $58,800 x 40% x 12/12 = $23,520 (*4) $35,280 x 40% x 12/12 = $14,112 (*5) $21,168 x 40% x 12/12 = $8,467 Depreciation for 2015 is $1,168 to keep book value same as salvage value. $21,168 - $20,000 = $1,168 (At this point, depreciation stops.)
5.2 [Example 2] single declining balance method Assume the price of a depreciating asset is P and its salvage value after N years is S. You could assume the asset depreciates by a factor of (or a rate of %). This method is known as Single Declining Balance. In an equation this looks like:
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[$20,000.00/5] = $4,000.00 $16,000.00 [$16,000.00/5] = $3,200.00 $12,800.00 [$12,800.00/5] = $2,560.00 $10,240.00 [$10,240.00/5] = $2,560.00 $8,192.00 [$12,800.00/5] = $2,560.00 $6,553.60
5.3 Advantages of the Declining balance method of depreciation The model accelerates depreciation compared to straight line. It gives a more realistic reflection of an asset's actual expected benefit from the use of the asset. Reducing balance method is easy to understand and simple to implement. Depreciation is calculated every year on the opening balance of asset. Reducing balance method equalizes the yearly burden on profit and loss account in respect of both depreciation and repairs. The amount of depreciation goes on decreasing while the expenses on repairs goes on increasing, so that the total charge against revenue over different years remains more or less the same. Reducing balance method is acceptable for income tax purposes Reducing balance method matches the cost and revenue of the business. The greater amount of depreciation provided in initial years is matched against the higher amount of revenue generated by increased production by the use of new asset (White et al 1994). 5.4 Disadvantages of the Declining balance method of depreciation It has an implied salvage that may be lower than the estimated salvage. Double-declining-balance depreciation does not always depreciate an asset fully by its end of life (Harrison et al, 1995). Reducing balance method charges heavy amount of depreciation in earlier years. The formula to obtain rate of depreciation can be applied only when there is residual value of the asset (Marullo et al, 1996).
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