Depreciation Reducing Balance Method
Reducing balance depreciation is one method to reduce the value of fixed assets on the balance sheet. Includes an Excel spreadsheet to calculate the depreciation.
What is Reducing Balance Depreciation?
Depreciation reducing balance method or Declining Balance is one of the main ways for calculating depreciation in your accounts. The other main method used is double declining balance depreciation and straight-line depreciation. Whichever method you choose to use for the fixed assets, you need to use the same method for the whole period of the asset life.
The depreciation-reducing balance method is used if an fixed asset needs to be written off at a higher value during the early years. An example of this may be some machinery equipment, which, as soon as purchased, the value is reduced very quickly and then slows down over time. Another example is a new car, which will lose more value in the first few years.
Depreciation reduces the asset’s monthly or annual value and adds a depreciation expense to the profit and loss account. It means that the value of the assets is written off over a period of time.
What is a Fixed Asset and Why do we need Depreciation?
Fixed assets are long-term investments in your business, such as property, land, or equipment. As a business, you want to depreciation them over several years to spread the cost out.
When you purchase a fixed asset, you’ll record it on your balance sheet as an asset at its purchase price. You’ll “depreciate” each year by recording a portion of that cost as an expense on your income statement. This will reduce your business’s taxable profits in that year.
Reducing balance depreciation is the main method used for depreciating assets that decline faster in the early years.
Reducing Balance Method vs Straight Line Method
The image uses the data from the example on this page and shows the difference between reducing balance and straight-line depreciation method.
As you can see, both methods start at 20,000 and finish at 1,500, but the rate they reduce is different. It is much faster to start using the declining balance method.
Depreciation Reducing Balance Method Example
To calculate this method, you need to choose a percentage rate of depreciation. For our example, we have purchased a new piece of machinery at £20,000 using a 40% rate of depreciation. The asset is depreciated over a period of 5 years and has a residual value of £1500 in the final year.
| Value start of year | Depreciation rate | Depreciation for year | Value of asset at y/e | ||
| Year 1 | £20,000 | 40% | £8,000 | £12,000 | |
| Year 2 | £12,000 | 40% | £4,800 | £7,200 | |
| Year 3 | £7,200 | 40% | £2,800 | £4,400 | |
| Year 4 | £4,400 | 40% | £1,760 | £2,640 | |
| Year 5 | £2,640 | 40% | £1,056 | £1,584 |
As you can see, there is £1584 remaining at the end of the 5-year period. So to get this figure correct, you will need to calculate the exact percentage that needs to be used.
Accounting Software to Calculate Reducing Balance Depreciation
Xero accounting Software
offers an efficient solution for calculating depreciation. The software allows users to input the initial cost of an asset and its expected useful life, after which it automatically calculates the depreciation amount using the method chosen. This ensures accuracy and consistency in recording depreciation expenses. Xero provides a detailed breakdown of the asset’s current value, accumulated depreciation, and book value, allowing for better asset management.
Once the depreciation is calculated, Xero automatically generates journal entries for the depreciation expense and accumulated depreciation accounts, making it easier to track these transactions in the general ledger. This not only saves time but also reduces errors that may occur when manually posting entries.
How to Calculate Reducing Balance Depreciation
There is a formula for calculating depreciation using the reducing balance method, which is as follows:
DB is a declining balance
Salvage value is the scrap value that you expect to get at the end of its useful life
Cost is the asset cost without VAT
You do not need to know the equation, as our template will calculate depreciation for you.
Excel Template – Depreciation Reducing Balance Method
Within Business Accounting Basics, we have two different calculators for working out your reducing balance figure. The first reducing balance calculator requires that you know the required percentage rate of depreciation and is calculated over a period of 5 years.
The second calculator uses a formula embedded in Microsoft Excel. We have set up a simple spreadsheet that uses the formula to calculate your figures. This Excel template only works if there is a residual value at the end of life up to a maximum period of 10 years.
Instructions for Excel depreciation reducing balance spreadsheet
- Download the declining balance depreciation Excel template.
- Only enter figures in the GREEN boxes.
- Enter the purchase price of the equipment.
- Enter the residual balance – this is the asset’s estimated value at the end of its life.
- Enter the number of years you wish to depreciate the asset over.
- Enter the number of months the assets need to be depreciated during the first year. E.g. If you purchased the asset in January and your year-end is at the end of March, this figure will be 3 months. The template will automatically calculate the number of months in the last year for you.
Once the figures are calculated, they can be used to enter the depreciation into the accounts. Each year a journal will be entered to adjust the depreciation. The journal will Debit depreciation expense in the profit and loss and credit accumulated depreciation in the balance sheet.
Reducing Balance Depreciation Conclusion
The reducing balance depreciation method, also known as the declining balance method, is a faster way to reduce the value of an asset over its lifetime in the earlier years.
The free Excel spreadsheet provided can help you calculate the figures needed to post your depreciation with this method in your accounting software. If you have a lot of assets, it can save time and ensure all calculations are done correctly.
Return from depreciation reducing balance method to fixed asset page.
