Depreciation Charge
Depreciation is an essential concept of accounting which every student must acknowledge and be aware of. If there is a reduction in the value of particular assets owing to decrement and the discontinuance of technology, it is known as depreciation. It is an expense in relevance to the profit and loss account by the end of the year.
This method of depreciation charge is precisely termed as Declining Charge Method. To derive the formula, the behavioural aspects of the assets for a definite period are taken to account. Following these methods, the depreciation sum is sure to reduce every successive year.
Charging Depreciation - Declining Charge Method
These methods are generally implemented when the receipts from the particular assets are on the verge of decline. In this case, modifying the depreciation charge for the asset turns out to be mandatory in order to meet the exact earning.
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Methods Falling Under Charging Depreciation
There are three methods of depreciation charges that come under this category.
Diminishing Balance Method
Sum of years' Digit Method
Double Declining Method
Now we will be seeing in detail the significance and concept of the Diminishing Balancing Method.
Diminishing Balance Method
As per the diminishing balance method, depreciation is charged on a particular percentage, in relevance to the asset’s book value, turning up in the balance sheet. There’s a book value reduction in the sheet every subsequent year. Therefore, it is also named Reducing Balance Method or Written Down Value Method i.e., loss of charge method.
Owing to the reduction of book value every year, there’s a decrease in the depreciation expense as well. Therefore, the value of the concerned asset is never directed to zero.
Advantages of Diminishing Balancing Method
The Diminishing Balancing Method comes with its advantages. They are listed below.
Every year there’s a decrease in depreciation, giving rise to repair expenses. Thus, the method poses an equal burden on each year’s profit.
With the aid of this method, depreciation is charged on, with relevance to the Income Tax Act.
A significant part of the depreciation charge is evaluated at the beginning of the year. Hence, it gets easier to replace the asset.
Disadvantages of Diminishing Balancing Method
However, the Diminishing Balancing Method isn't devoid of cons as well. The same is detailed here.
Following this method, it gets tough to correctly evaluate the figures for charging depreciation. It often appears to be an incomplete Depreciation of the full asset.
The figures of the asset never direct to zero.
With this method of Diminishing Balancing, it is not possible to evenly spread the Depreciation throughout the assets' life.
Every year, the depreciated rate is drafted as a percentage. It is known as the depreciation rate. The formula for Depreciation charge is presented as, 2*straight line*book value during the starting of the accounting period.
Did You Know?
Here are some of the most amazing facts about Depreciation that you would be surprised to see.
Assets such as land, stocks, sums, building, investment, etc., can’t be depreciated.
Diamonds, some particular brands' watches and more, don't lose their value.
Car is a depreciating asset and loses value as time goes.
Expenses are always better than Depreciation.
BMW 5 series, is the super fastest depreciating asset.
Solved Example
1: How Many Types of Assets are There?
Assets are regarded as a particular element, which is liable for investment and has value as well. Suppose a particular sum such as stocks is said to be an asset. Whereas, your personal properties like house or even bank account are assets too. Depreciation is charged on the assets.
There are three categories of assets.
Tangible and intangible assets.
Current and fixed assets.
Operating and non-operating assets.
The assets' category is variable depending on their nature and type. Stocks or sum belongs to a particular category, whereas savings account or personal property such as a car belongs to the other.
Now we will be going through some of the common questions that people often face while solving Depreciation queries.
FAQs on Depreciation: Declining Charge Method Overview
1. What is the Declining Charge Method of depreciation, and how does it work?
The Declining Charge Method, also known as the Written Down Value (WDV) or Diminishing Balance Method, is a form of accelerated depreciation. Under this method, a fixed percentage of depreciation is applied to the asset's book value (cost minus accumulated depreciation) each year. This results in a higher depreciation expense in the early years of an asset's life and a progressively lower expense in later years, reflecting the asset's decreasing utility over time.
2. How do you calculate depreciation using the Declining Charge Method formula?
The formula to calculate annual depreciation using this method is:
Annual Depreciation = Book Value of the Asset at the beginning of the year × Rate of Depreciation (%)
Here, the 'Book Value' is the original cost of the asset minus all the depreciation that has been charged in previous years. The rate of depreciation remains constant throughout the asset's useful life.
3. Can you provide a simple example of calculating depreciation with the Declining Charge Method?
Certainly. Imagine a machine is purchased for ₹50,000 with a depreciation rate of 20% per year under the Declining Charge Method. The calculation would be as follows:
- Year 1: Depreciation = 20% of ₹50,000 = ₹10,000. The new book value is ₹40,000.
- Year 2: Depreciation = 20% of ₹40,000 (the new book value) = ₹8,000. The new book value is ₹32,000.
- Year 3: Depreciation = 20% of ₹32,000 = ₹6,400. The new book value is ₹25,600.
As you can see, the depreciation amount decreases each year.
4. What is the main difference between the Declining Charge Method and the Straight Line Method (SLM)?
The primary difference lies in the basis of calculation and the resulting depreciation amount each year.
- Basis of Calculation: The Declining Charge Method calculates depreciation on the book value (diminishing value) of the asset, while the Straight Line Method (SLM) calculates it on the original cost.
- Depreciation Amount: Under the Declining Charge Method, the depreciation expense is high initially and decreases annually. In contrast, the depreciation expense remains constant every year under SLM.
- Asset Value: The book value of an asset never becomes zero under the Declining Charge Method, whereas under SLM, it can be reduced to its scrap value or zero.
5. For which types of assets is the Declining Charge Method most suitable, and why?
This method is most suitable for assets that have higher efficiency and earning capacity in their initial years, which declines as they age. This includes assets like machinery, vehicles, computers, and other electronic equipment. The logic is to match higher depreciation costs in the early years with the asset's higher performance and lower repair costs. As the asset gets older and requires more maintenance, the depreciation charge decreases, helping to even out the total expense over the asset's life.
6. Is the Declining Charge Method the same as the Written Down Value (WDV) or Diminishing Balance Method?
Yes, these terms are used interchangeably. Declining Charge Method, Written Down Value (WDV) Method, and Diminishing Balance Method all refer to the same principle of charging depreciation on the decreasing book value of an asset. In the context of the CBSE Class 11 Accountancy syllabus and general accounting practice, they mean the same thing.
7. Why is a higher amount of depreciation charged in the initial years under the Declining Charge Method?
A higher depreciation is charged in the initial years to adhere to the matching principle of accounting. An asset is generally more productive and generates more revenue when it is new. By charging a larger portion of its cost as depreciation during these productive years, the expense is better matched against the revenue it helps to earn. As the asset's efficiency and repair costs increase with age, the lower depreciation charge in later years helps balance the overall burden on the profit and loss account.
8. What are the key advantages of using the Declining Charge Method for a business?
The key advantages include:
- Realistic Expense Allocation: It is considered more logical as it charges more depreciation when the asset is most efficient and less when it is older and less productive.
- Balanced Charge against Profit: The total charge to the profit and loss account (Depreciation + Repair Costs) remains relatively uniform over the years.
- Approval for Tax Purposes: This method is recognised by income tax authorities, allowing businesses to claim higher depreciation for tax benefits in the early years.
9. What is a major limitation of the Declining Charge Method, and can an asset's value ever become zero using this method?
A significant limitation is that the book value of an asset can never be technically reduced to zero. Since depreciation is always calculated as a percentage of the remaining balance, there will always be a small residual value left in the books. This means the asset is never fully written off through depreciation alone, which can sometimes complicate accounting for asset disposal. Furthermore, determining an appropriate depreciation rate can be more complex than with the Straight Line Method.
