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Understanding Depreciation: Straight-Line & Declining Balance Methods Explained

This chapter discusses depreciation methods in farm management, specifically focusing on the Straight-Line and Declining Balance methods. It explains how to calculate annual depreciation based on cost, salvage value, and useful life. Examples illustrate the calculation process for both methods, including circumstances to switch methods when applicable. Key points highlight the importance of not depreciating below salvage value and when to shift to the Straight-Line method from the Declining Balance approach based on remaining useful life.

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Understanding Depreciation: Straight-Line & Declining Balance Methods Explained

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  1. Farm Management Chapter 4 Depreciation Examples

  2. Straight Line Cost – Salvage Value Annual Depreciation = Useful Life Or Annual Depreciation = (Cost – Salvage Value) x R where R is found by dividing 100% by usefullife

  3. Declining Balance Annual Depreciation = Beginning Year Book Value x R R is a constant percentage rate. Its value depends on useful life and the type of declining balance chosen. It is a multiple of the straight line rate.

  4. Examples Calculate depreciation for a machine with a cost of $10,000, a salvage value of $2,000, and a useful life of 10 years.

  5. Using Straight Line ($10,000 – $2,000) Annual Depreciation = 10 = $800 Annual depreciation will be the same every year under this method.

  6. Using Double Declining Balance Year 1: $10,000 x 20% = $2,000 Year 2: $ 8,000 x 20% = $1,600 Year 3: $ 6,400 x 20% = $1,280 100% 20% = 2 x 10 useful life

  7. Using 150% Declining Balance Year 1: $10,000 x 15% = $1,500 Year 2: $ 8,500 x 15% = $1,275 Year 3: $ 7,225 x 15% = $1,084 100% 15% = 1.5 x 10 useful life

  8. When Using Declining Balance • If there is a salvage value greater than zero, declining balance methods can result in the salvage value being reached before the end of the useful life. Depreciation must stop when book value = salvage value. • If salvage value is zero, it is necessary to switch from declining balance to straight line (on the remaining value and remaining life) at some point to get all the depreciation allowed.

  9. Things to notice • do not subtract salvage value for DDB • the book value changes (gets smaller) every year so depreciation gets smaller every year as well. • don’t allow the book value to fall below the salvage value. • if the salvage value is zero, you must switch to straight line at some point.

  10. You can’t depreciate below salvage value!

  11. Corrected depreciation

  12. Switching to straight line If an object has a salvage value of zero, you must switch to straight line at some point. Switch when straight line, on the remaining value over the remaining life, gives the same or higher depreciation than DDB would give.

  13. Let the Salvage Value = 0 Using DDB, we do not get to 0

  14. switch to straight line in year 6

  15. Easier way to figure out when to switch Divide the years of remaining life into the number “1.” When that fraction is greater than 2/L, switch.

  16. Example If the years of useful life are 5, then 2/5 = 0.40. Calculated 1 /(remaining life) year 1 1/5 = 0.20 year 2 1/4 = 0.25 year 3 1/3 = 0.33 year 4 1/2 = 0.50 switch in year 4

  17. Example If the years of useful life are 7, then 2/7 = 0.2857... Calculated 1 /(remaining life) year 1 1/7 = 0.143 year 2 1/6 = 0.166 year 3 1/5 = 0.20 year 4 ¼ = 0.25 year 5 1/3 = 0.33 switch in year 5

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