Diminishing Balance Method of Depreciation:

Learning Objectives:

1. Define, explain and give example of the diminishing balance method/written down value method/reducing installment method?

2. What are advantages and disadvantages of diminishing balance method?

Definition and Explanation:

Diminishing balance method is also known as written down value method or reducing installment method. Under this method the asset is depreciated at fixed percentage calculated on the debit balance of the asset which is diminished year after year on account of depreciation.

Journal Entries:

The entries in this case will be identical to those discussed in the case of the fixed installment method. Only the amount will be differently calculated.

Advantages of Diminishing Balance Method:

1. The strongest point in favor of this method is that under it the total burden imposed on profit an loss account due to depreciation and repairs remains more or less equal year after year since the amount after depreciation goes on diminishing with the passage of time whereas the amount of repairs goes on increasing an asset grow older.

2. Separate calculations are unnecessary for additions and extensions, though in the first year some complications usually arise on account of the fact that additions are generally made in the middle of the year.

Disadvantages of Diminishing Balance method:

1. This method ignores the question of interest on capital invested in the asset and the replacement of the asset.

2. This method cannot reduce the book value of an asset to zero if it is desired.

3. Very high rate of depreciation would have to be adopted other wise it will take a very long time to write an asset down to its residual value

Scope of Application:

Diminishing balance method of depreciation is most suited to plant and machinery where additions and extensions take place so often and where the question of repairs is also very important. Written down value method or reducing installment method does not suit the case of lease, whose value has to be reduced to zero.

Example:

On 1st January, 1994, a merchant purchased plant and machinery costing $25,000. It has been decided to depreciate it at the rate if 20 percent p.a. on the diminishing balance method (written down value method). Show the plant and machinery account in the first three years.

Plant and Machinery Account

Formula or equation for the depreciation calculation may be written as follows:

*First year: 25,000 × 20% = 5000

**Second Year: (25000 – 5000) × 20% = 4,000

***Third Year: [25000 – (5,000 + 4,000)] ×  20% =  3,200

You may also be interested in other articles from “accounting for depreciation” chapter:

1. Definition and Explanation of Depreciation
2. Causes of Depreciation
3. Need for Depreciation
4. Depreciation, Depletion and Amortization
5. Difference Between Depreciation and Fluctuation
6. Basic Factors of Determination of Depreciation
7. Depreciation Methods / Methods for Providing Depreciation
8. Fixed Installment Method / Straight Line Method / Original Cost Method
9. Diminishing balance/written Down Value/Reducing Installment Method of Depreciation
10. Annuity Method of Depreciation
11. Depreciation Fund Method or Sinking Fund Method
12. Insurance Policy Method of Depreciation
13. Revaluation Method of Depreciation
14. Sum of the Years’ Digits Method of Depreciation
15. Double Declining Balance Method of Depreciation
16. Depletion Method of Depreciation
17. Basis of Use System of Depreciation
18. Depreciation Of Various Assets
19. Depreciation Accounting – General Questions and Answers