Depreciation is a means of cost allocation for capital assets. Companies use different depreciation methods, depending on asset types, to appropriately account for depreciation charges over multiple accounting periods. A depreciation charge can be expressed as an asset's depreciation base multiplied by the depreciation rate, which are the main concerns of the depreciation method. The diminishing-balance method and straight-line method define depreciation base and depreciation rate differently.
Depreciation base is the cost, or value, of an asset that is to be expensed over multiple accounting periods. The initial depreciation base, or the balance of an asset's value at the beginning of the first period, is often an asset's purchase cost less any salvage value, which is the remaining worth of the asset after it is removed from service. Depending on the depreciation method used, companies may have a constant depreciation base for all periods or it may be changed from period to period. The change is accomplished by subtracting a period's depreciation charge from the amount of the depreciation base at the beginning of the period to arrive at the depreciation base for the next period.
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A depreciation rate can be expressed as a percentage or fraction. Some depreciation methods use a constant depreciation rate for all periods; some use variable rates for different periods; and others may use rates that decline over an asset's life. Given the same depreciation base, the use of different depreciation rates results in depreciation charges of varying amounts. Certain depreciation methods calculate depreciation rates based on the number of years of an asset's useful life.
Straight Line Method of Depreciation
The straight-line method of depreciation uses both a constant depreciation base and a constant depreciation rate through all periods. The depreciation base for each period is an asset's purchase cost less any salvage value. For a 10-year asset, the depreciation rate would be one-tenth, or 10 percent, of the 100 percent depreciation rate. The straight-line method assumes that an asset declines in value or usefulness with the passage of time, which is conceptually appropriate for assets that provide even benefits throughout their economic lifespans.
Diminishing Balance Method of Depreciation
The diminishing-balance method of depreciation is partly based on the straight-line method because its depreciation rate is a multiple of the straight-line rate. For example, the depreciation rate of the diminishing-balance method can be twice the straight-line rate if using the double-declining-balance method. Like the straight-line method, the diminishing-balance method has a constant depreciation rate; unlike the straight-line method, the diminishing-balance method uses a diminishing depreciation base that decreases each period by the amount of the depreciation charge for that period. Note that the starting depreciation base uses an asset's full purchase cost, but the asset is depreciated only to its salvage value.