Declining-Balance (or Fixed Percentage) Method

 The annual depreciation cost is a fixed percentage of

the property value at the beginning of the particular
year.

 The fixed-percentage (or declining-balance) factor

remains constant throughout the entire service life of
the property

 The annual cost for depreciation is different each

year.
The above equation determines the fixed percentage
factor, and the equation is sometimes designated as
the Matheson formula.
Comparison of
straight-line,
Multiple straight-line,
sum-of-the-years-digits,
and declining-balance
methods for determining
depreciation.
Comparison with the straight-line method

 Declining-balance depreciation permits the

investment to be paid off more rapidly during the
early years of life.

 The increased depreciation costs in the early years are

very attractive to concerns just starting in business,
because the income-tax load is reduced at the time
when it is most necessary to keep all pay-out costs at
a minimum.
 The textbook relationship presented in the previous
eq’s is seldom used in actual practice, because it
places too much emphasis on the salvage value of the
property.

 It is certainly not applicable if the salvage value is

zero.

 To overcome this disadvantage, the value of the

fixed-percentage factor is often chosen arbitrarily
using a sound economic basis .
Double declining balance method or 200% method:

 f = Two times the reciprocal of the service life n

when salvage valve is zero.

 f=Two times the min.depreciation rate obtained with

st.line method when salvage value is not zero.

 This permits approximately two-thirds of the

depreciable value to be written off in the first half of
the useful 1ife.
 It should be noted that the value of the asset cannot
decrease to given salvage value at the end of the
service life and may possibly be greater than the
salvage or scrap value.

 To handle this difficulty, it is sometimes desirable to

switch from the declining-balance to the straight-line
method after a portion of the service life has expired.
This is known as the combination method.

 It permits the property to be fully depreciated during

the service life, yet also gives the advantage of faster
early-life write-offs.
The main advantage of the declining-balance and the
combination methods is

 They permit greater depreciation allowances in the

early life of the property than in the later life.

 They are particularly applicable for units in which

the greater proportion of the production occurs in the
early part of the useful life or when operating costs
increase markedly with age.
Types of declining-balance
methods for determining
depreciation.
Q)The original value of a piece of equipment is
$22,000, completely installed and ready for
use. Its salvage value is estimated to be $2000
at the end of a service life estimated to be 10
years. Determine the asset (or book) value of
the equipment at the end of 5 years using:
(a) Straight-line method.
(b) Textbook declining-balance method.
(c) Double declining-balance (200 percent)
method
Sum-of-the-Years-Digits Method:

 The annual depreciation is based on the number of

service-life years remaining and the sum of the
arithmetic series of numbers from 1 to n, where n
represents the total service life.

 The yearly depreciation factor is the number of useful

service-life years remaining divided by the sum of the
arithmetic series.

 Annual depreciation cost =

Yearly depreciation factor X the total depreciation (v-vs)
• The equations which apply for determining annual
depreciation by the sum-of-the-years-digits method
are
This method gives results similar to those
obtained by the declining-balance method.

Larger costs for depreciation are allotted

during the early-life years than during the later
years.

This method has the advantage of permitting

the asset value to decrease to zero or a given
salvage value at the end of the service life.
Q)The initial installed cost for a new piece of equipment is
$10,000, and its scrap value at the end of its useful life is
estimated to be $2000. The useful life is estimated to be 10
years. After the equipment has been in use for 4 years, it is
sold for $7000. The company which originally owned the
equipment employs the straight-line method for determining
depreciation costs. If the company had used an alternative
method for determining depreciation costs, the asset (or book)
value for the piece of equipment at the end of 4 years would
have been $5240. The total income-tax rate for the company is
34 percent of all gross earnings. Capital-gains taxes amount to
34 percent of the gain. How much net saving after taxes would
the company have achieved by using the alternative (in this
case, reducing-balance) depreciation method instead of the
straight-line depreciation method?
Q) A property has an initial value of $50,000, service
life of 20 years, and final salvage value of $4000. It
has been proposed to depreciate the property by the
text-book declining-balance method. Would this
method be acceptable for income-tax purposes if the
income-tax laws do not permit annual depreciation
rates greater than twice the minimum annual rate with
the straight-line method?
Q) A piece of equipment having a negligible salvage
and scrap value is estimated to have a service life of
10 years. The original cost of the equipment was
$40,000.
Determine the following:
(a) The depreciation charge for the fifth year if double
declining-balance depreciation is used.
(b) The depreciation charge for the fifth year if sum-of-
the-years-digits depreciation is used.
© The percent of the original investment paid off in the
first half of the service life using the double
declining-balance method.
(d) The percent of the original investment paid off in the
first half of the service life using the sum-of-the-
years-digits method.
Q)A concern has a total income of $1 million/year, and
all expenses except depreciation amount to
$6OO,OOO/year. At the start ,of the first year of the
concern’s operation, a composite account of all
depreciable items shows a value of $850,000, and the
overall service life is estimated to be 20 years. The
total salvage value at the end of the service life is
estimated to be $50,000. Thirty percent of all profits
before taxes must be paid out as income taxes. What
would be the reduction in income-tax charges for the
first year of operation if the sum-of-the-years-digits
method were used for depreciation accounting instead
of the straight-line method?
Q)The total value of a new plant is $2 million. A certificate of
necessity has been obtained permitting a write-off of 60
percent of the initial value in 5 years. The balance of the plant
requires a write-off period of 15 years. Using the straight-line
method and assuming negligible salvage and scrap value,
determine the total depreciation cost during the first year.

Q)In order to make it worthwhile to purchase a new piece of

equipment, the annual depreciation costs for the equipment
cannot exceed $3000 at any time. The original cost of the
equipment is $30,000, and it has zero salvage and scrap value.
Determine the length of service life necessary if the equipment
is depreciated (a) by the sum-of-the-years-digits method, and
(b) by the straight-line method.
Q) An asset with an original cost of $10,000 and no
salvage value has a depreciation charge of $2381
during its second year of service when depreciated by
the sum-of digits method. What is its expected useful
life?

Q) A materials-testing machine was purchased for

$20,000 and was to be used for 5 years with an
expected residual salvage value of $5000. Graph the
annual depreciation charges and year-end book
values obtained by using:
(a) Straight-line depreciation.
(b) Sum-of-digits depreciation.
© Double-declining-balance depreciation.
Sinking-Fund Method:
 This method takes compound interest.

 It is assumed that the basic purpose of depreciation allowances

is to accumulate a sufficient fund to provide for the recovery
of the original capital invested in the property.

 An ordinary annuity plan is set up where in a constant amount

of money should theoretically be set aside each year.

 At the end of the service life, the sum of all the deposits plus
accrued interest must equal the total amount of depreciation.
Total amount of depreciation after a years = V - V,
Salient features of sinking fund method :

 The yearly cost for depreciation is constant when the sinking-

fund method is used
 This method results in book values which are always greater
than those obtained with the straight-line method.
 Because of the effects of interest in the sinking-fund method,
the annual decrease in asset value of the property is less in the
early-life years than in the later years.
 Theoretically, the method would be applicable for depreciating
any property that did not undergo heavy service demands
during its early life and stood little chance of becoming
obsolete or losing service value due to other functional causes.
 Although the sinking-fund viewpoint assumes the
existence of a fund into which regular deposits are
made, an actual fund is seldom maintained. Instead,
the money accumulated from the depreciation charges
is put to work in other interests, and the existence of
the hypothetical fund merely serves as a basis for this
method of depreciation accounting.
SINGLE-UNIT AND GROUP DEPRECIATION :

• In depreciation accounting procedures, assets may be depreciated

on the basis of individual units or on the basis of various types of
property groups or classifications.

The single-unit method:

 In this method assets are be depreciated on the basis of individual
units .
 It requires keeping records on each individual asset.
 This method is simple, But the large number of detailed records
are required which makes the accounting expenses very high.
• To simplify the accounting procedures, many
concerns combine their various assets into groups for
depreciation purposes.
• There are several types of group accounts
employed, and the most common among these are
composite accounts, classified accounts, and vintage-
group accounts.
• composite accounts:
Includes all depreciable assets in one single group,
and an overall depreciation rate is applied to the
entire account.
With this method, the composite depreciation rate
must be re determined when important changes occur
in the service lives of the individual assets.
Classified accounts :
 It is possible to classify properties into general
types, such as machinery and equipment, office
furniture and fixtures, buildings, and
transportation equipment. The records for these
groups are known as classified accounts.
A classified account is similar to a composite
account because many items are included in the
same group, regardless of life characteristics
vintage-group accounts :

 It includes similar assets having approximately the

same service lives.
 A separate record is kept for each group and the same
depreciation rate is applied to all the items included in
each account.
 With this method, the advantages of single-unit
depreciation are obtained since life characteristics
serve as the basis.
• The total value of a new plant is $2 million. A
certificate of necessity has been obtained permitting a
write-off of 60 percent of the initial value in 5 years.
The balance of the plant requires a write-off period of
15 years. Using the straight-line method and
assuming negligible salvage and scrap value,
determine the total depreciation cost during the first
year.
• A materials-testing machine was purchased for
$20,000 and was to be used for 5 years with an
expected residual salvage value of $5000. Graph the
annual depreciation
charges and year-end book values obtained by using:
(a) Straight-line depreciation.
(b) Sum-of-digits depreciation.
© Double-declining-balance depreciation
• An asset with an original cost of $10,000 and
no salvage value has a depreciation charge of
$2381 during its second year of service when
depreciated by the sum-of digits method. What
is its expected useful life?