Finance: What is Double Declining Balance Depreciation?

Double declining balance sheet depreciation is a structure of formula under which companies assess the depreciating value of an asset that loses value.

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Transcript

00:25

different from normal depreciation like a tractor smelting Factory or the break [A bucket of molten metal being poured]

00:31

room vending machine which used to deposit KitKat bars but has been hanging [KitKat bar gets stuck in the machine]

00:35

on to that one bar since 1992 we got to depreciate those well if Shmaterpiller

00:40

has a smelting Factory they paid a hundred million bucks to build which [100 million bucks price tag appears]

00:44

will be sold for salvage value or scrap for ten million bucks in 20 years then

00:49

the decline in total value over that time will be ninety million bucks yep [Decline in value calculation]

00:54

over twenty years or four and a half million dollars each year if the company

00:59

used straight-line depreciation to account for the loss in value of that [Straight line on a value/time graph]

01:04

smelting Factory but under double declining balance depreciation systems

01:09

the deduction rate is essentially double the straight-line amounts it's still the

01:14

same total amount of deduction it's not like the value of the tractor factory

01:18

changed either at purchase time or scrap time but the speed and timing of the [Timeline of depreciation]

01:24

depreciation changed to favor high depreciation in the early years giving

01:29

the company lower profits but also lower taxes [The first 5 years on the timeline are highlighted]

01:32

well the accounting rationale follows suit the utility or value of the asset

01:37

is in fact not declining in true market value in a steady state straight-line [Stop sign appears over the value graph]

01:44

over twenty years try to convince a buyer that your car

01:47

has depreciated only five percent in value a year after you bought it new [Car for sale on eBay]

01:51

yeah not happening depreciate way more than that so in double declining balance

01:55

depreciation instead of deducting four-and-a-half million bucks a year the

01:59

company would deduct nine million a year each year with some adjustments along

02:04

the way and yes we're way over generalizing on that statement until [Overgeneralizing flashing red]

02:07

that smelting Factory was fully deducted away to whatever terminal salvage value

02:12

or scrap value they predicted it would then sell [Factory value declining]

02:15

for that is if a normal depreciation was taking four-and-a-half million bucks a

02:20

year for 20 years or four-and-a-half percent of the total initial cost then [Straight line depreciation per year]

02:24

double declining balance depreciation would take double that number or nine

02:30

percent of the hundred million dollars in year one

02:34

so they deduct nine million right upfront and your one right goes from 100

02:38

to ninety one on the sheets and in reality that's probably a lot closer to [Price tag decreasing]

02:42

what the actual loss and market value of the smelting machine and would look like

02:46

all right well then in year two double declining balance depreciation would

02:49

again take double the flat rate of that four inhabitant they double it to nine

02:54

percent of the remaining book value of the smelter or nine percent of the

02:58

remaining 91 million that it's worth or about 8.2 million in incremental [Double declining balance depreciation per year]

03:03

depreciation for that year leaving the value ninety one - 8.2 or eighty two

03:08

point eight million dollars in year three the value of the shelter would

03:12

drop another nine percent to about seventy five point four million say we

03:16

did all the math therefore there no extra charge and in year four down nine [Post it note showing the calculation]

03:20

percent again to around sixty eight point six million dollars so up to this

03:24

point the set of deductions would look like this there we go all that stuff you [Amount depreciated in the first 4 years is shown]

03:28

notice that as we've gone along here we've taken the beginning of the year

03:32

book value of the smelter as the starting point against which to take our

03:37

nine percent deduction if we take nine percent always well we'll never get to

03:42

zero or rather to the scrap value target there of ten million bucks right nine [The value in the 20th year is shown]

03:47

percent and keep just being a tiny tiny amount on those out years so in practice

03:51

at some point when companies have depreciated the crap out of their

03:55

capital assets well then they switch to straight-line depreciation in this case

03:59

after say year five our smelter would be valued at sixty two point four million

04:05

dollars ish with fifty two point four million left to depreciate to hit that

04:10

ten million dollar scrap value for about three point five million a year for the [Calculation of loss per year is shown]

04:14

remaining fifteen years until finally yes Bessie is a put out to pasture the [The factory is thrown into the trash]

04:20

gist of double declining balance sheets appreciation is to let companies pay

04:23

less in taxes early in their history having more cash to

04:27

build their businesses and grow faster at the price of showing lower accounting

04:32

earnings and that's just okay with Wall Street so yeah here's to hoping they [Someone doing an okay sign next the Wall St. sign]

04:35

deploy that cash into after know something a little more fun [Money going down a water slide]