Double Declining Balance Depreciation Method

Kinda sounds like that strange-looking British double decker bus, right?

But it’s not. Instead, it’s a structure or formula under which companies assess the depreciating value of an asset that…loses value. Like a tractor smelting factory, or the break room vending machine, which used to deposit Kit Kat bars, but has been hanging onto that one bar since 1992.

If Shmaterpillar has a shmelting factory they paid 100 million to build, which will be sold for salvage value or scrap for 10 million in 20 years, then the decline in total value will be 90 million over 20 years, or four and a half million a year each year, if the company used straight line depreciation to account for the loss in value of that factory.

But under the double declining balance depreciation system, the deduction rate is double the straight line amounts. It’s still the same total amount of deduction; it's not like the value of the tractor factory changed either at purchase time or scrap time, but the speed and timing of the depreciation change to favor high depreciation in the early years, giving the company lower profits, but also lower taxes.

The accounting rationale follows suit: the utility or value of the asset is, in fact, not declining in true market value in a steady straight line over 20 years. Try to convince a buyer that your car has depreciated only about 5 percent in value a year after you bought it new. Yeah. Not happening.

So in double declining balance depreciation, instead of deducting 4 ½ million a year... the company would deduct 9 million a year, each year, with some adjustments along the way, until that shmelting factory was fully deducted away to whatever terminal salvage or scrap value they predicted it would then sell for. That is, if a normal depreciation was taking 4.5 million a year for 20 years, or 4.5 percent of the total initial cost, then double declining balance depreciation would take double that number, or 9 percent of the 100 million in year one...so they’d deduct 9 million right up front. And, in reality, that’s probably a lot closer to what the loss in market value of the shmelting machine would look like.

Then, in year two, double declining balance depreciation would again take double the flat rate of 9% of the remaining book value of the shmelter...or 9% of the remaining 91 million...or about 8.2 million, leaving the value 91 minus 8.2...or 82.8 million.

In year three, the value of the shmelter would drop another 9% to about 75.4 million, and in year four, down 9% to around $68.6 million. Notice that, as we’ve gone along here, we have taken the beginning of year book value of the shmelter as the starting point, against which we take our 9 percent deduction. If we take 9 percent always...we’ll never get to zero. Or rather to the scrap value target of 10 million bucks. So in practice, at some point, when companies have depreciated the crap out of their capital assets, they switch to straight line depreciation. In this case, after year five, our shmelter would be valued at about 62.4 million, with 52.4 million left to depreciate to hit that 10 million scrap value...or about 3.5 million a year for the remaining 15 years...until Bessie is finally put out to pasture.

The gist of double declining balance sheet depreciation is to let companies pay less in taxes, having more cash to build their businesses and grow faster, at the price of showing lower accounting earnings.

So yeah. Here’s to hoping they deploy that cash into, uh...something fun.