Depreciation Account: Diminishing or Reducing Balance Method: Meaning, Formula, And Preparation - SS1 Accounting Lesson Note
The diminishing or reducing balance method of depreciation is another way of allocating the cost of a tangible asset over its useful life. Unlike the straight-line method that assumes the asset depreciates at an equal rate over its useful life, the reducing balance method assumes that the asset depreciates at a faster rate in the early years of its useful life and at a slower rate in the later years. The formula for calculating depreciation using the reducing balance method is:
Depreciation expense = Book value of the asset x Depreciation rate
Where the book value of the asset is the cost of the asset less accumulated depreciation, and the depreciation rate is the percentage rate at which the asset is expected to depreciate each year.
To prepare the depreciation schedule using the reducing balance method, the following steps should be taken:
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Determine the cost of the asset, expected salvage value, and useful life
Determine the depreciation rate by dividing 100% by the useful life of the asset
Calculate the depreciation expense for the first year by multiplying the book value of the asset at the beginning of the year by the depreciation rate
Subtract the depreciation expense from the book value of the asset to get the book value at the end of the year
Repeat two previous steps for each subsequent year until the asset is fully depreciated
Example:
If a company purchases a machine for ₦1,000,000 with an expected useful life of 5 years and a salvage value of ₦100,000, and uses a depreciation rate of 40%, the depreciation schedule for the first three years would be as follows:
Book value at the beginning of the year = ₦1,000,000
Depreciation expense = ₦1,000,000 x 40% = ₦400,000
Book value at the end of the year = ₦1,000,000 - ₦400,000 = ₦600,000
Book value at the beginning of the year = ₦600,000
Depreciation expense = ₦600,000 x 40% = ₦240,000
Book value at the end of the year = ₦600,000 - ₦240,000 = ₦360,000
Book value at the beginning of the year = ₦360,000
Depreciation expense = ₦360,000 x 40% = ₦144,000
Book value at the end of the year = ₦360,000 - ₦144,000 = ₦216,000