Double Declining Balance
The double-declining-balance method requires the use of a depreciation rate that doubles the rate of a straight-line depreciation. For example, the straight-line depreciation rate for a 10-year asset would be 10 percent for each year, or one-tenth of the 100 percent full depreciation rate. As a result, the depreciation rate for the double-declining-balance method would be doubled to be 20 percent. The depreciation rate is then used to multiply the depreciation base to arrive at the allocated depreciation expense. Using the double-declining-balance method, depreciation base for each period is the depreciation balance of the previous period subtracted by the depreciation expense of that period. Therefore, depreciation base, or depreciation balance, declines over time, and when applied to the constant double depreciation rate, the declining depreciation base also causes depreciation expense to decline over time.
Matching Asset Value
Certain assets provide the most of their usable value during the early years of their services. For example, some technologically advanced equipment or devices may become obsolete gradually as new products come to the market. While such assets benefit a company’s the most in the early years, they also decline in value the most in the early years and should have higher depreciation for the same periods. Depreciation expense is an asset’s cost allocation intended to reflect the actual benefit of using the asset over the same period. The double-declining-balance method, allocating higher depreciation expenses in the early years of an asset’s uses, can better match cost with benefit from an asset use.
Maximizing Tax Deduction
As companies derive more value from the use of certain assets in the early years of their economic life, they likely generate more revenues and profits in the early years than in the later years. An evenly allocated depreciation expense would give companies an disadvantage when using depreciation expense as a tax deduction. To minimize tax payments by maximizing tax deductions, companies should apply the double-declining-balance method that allows higher depreciation expenses allocated in early years to offset higher revenues and profits during the same periods.
Offsetting Maintenance Costs
All assets decline in value over time and may need considerable amount of maintenance costs to keep assets in a fair use in later years. Any additional maintenance costs would be deductions from a company’s reported profits. Therefore, a company may want to allocate as little depreciation expenses as possible in later years so that it would not add more cost deductions to reduce reported profits. The double-declining-balance method allocates depreciation expenses in a declining manner in later years and can help offset the increased maintenance costs with less depreciation expenses during the same periods.