Diminishing Balance Method

Diminishing Balance Method of Depreciation

Diminishing balance method in accounting is the method by which the total amount of the depreciation can be calculated like some fixed percentage of the diminishing and reducing value of any asset that can stand in books during the beginning of an annual year so that it can bring the book value down to its initial residual value. The depreciation amount decreases every year. This means that the depreciation amount does not remain fixed but gradually decreases annually. It is also said that the depreciation method is the same as the Fixed Instalment Method. 

How to Calculate Diminishing Value Depreciation 

While purchasing an asset at the beginning of the year, one needs to calculate the total depreciation for that whole year applying the diminishing value method.

To do so, one needs to follow some instructions and few methods by using the Reducing Balance Method. It comes under the diminishing balance method other names. The steps are as follows:

  1. One has to find the correct rate of depreciation

  2. Subtract the total scrap value from the total asset cost

  3. Multiply the whole book value by maintaining the depreciation rate

Diminishing Balance Method Formula 

Diminishing refers to reduction or decline. Hence, diminishing method refers to the reduction or declining method. 

 Thus, the diminishing balance method formula is:

Depreciation expenses = (Net Book Value – Residual Value) * Depreciation Rate 

  • Depreciation expenses are the charge of the fixed assets that are converted to the income statement of that specific period. The period can be a week or a month or a year. 

  • Net Book Value refers to the value of the fixed asset that appears after depreciation. The asset of the Net Book value is equal to the total cost of the initial recognition that can be reduced because of the depreciation. 

  • The fixed asset of the residual value is the value that is expected from the fixed asset at the end of the period that is given to the asset.

  • The diminishing value depreciation method includes the rate that is provided to the people for particular assets. 

Examples of diminishing Value Depreciation Method

For example, a company has brought a car that values INR 500,000 and the useful life of the car as expected by the buyers is ten years. And the residual value is expected to be INR 24,000. 

Hence, using the diminishing method calculate the depreciation expenses. 

The rate of depreciation is 60%

The formula says: Depreciation expenses = (Net Book Value – Residual Value) * Depreciation Rate 

The value of the statement is as follows:

  • Net Book Value = INR 500,000 (in the first year which is equal to the cost of the car)

  • Residual Value = INR 24,000

  • Depreciation Rate = 60%

Therefore, the solution will be:

Depreciation Expense= (500, 000 – 24,000)* 60% = INR 2,85,600

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FAQs (Frequently Asked Questions)

1. Which is the other method that assumes the fact that the asset should be depreciated for more than that in the early years and less in its later years?

The other method that assumes the fact that the asset must be depreciated for more in the early years than in the later years is called the written down value method. It also has other names that include Diminishing Balance Method or the Reducing Balance. In this method, the depreciation value is calculated in a fixed percentage year on the particular value of the decreasing book that is generally known as the WDV of that asset. 

2. Although, the written-down value method is said to be more realistic, yet in some places, it suffers from a few limitations. Name some of the limitations.

The written down value method has few limitations, and they are the following:

  • This particular method does not allow or take into consideration the interest of the capital that is invested in that asset.

  • It also does not deliver a replacement for that asset on the expiry of its life.

  • In this case, the formula can only be applied when there is a presence of a residual value of that asset.

3. Name as well as explain various types of reserves.

  • Revenue Reserves: Revenue reserves are the reserves that are created from several revenue profits that can arise from the normal activities for the various businesses which can be freely available otherwise for the distribution of the dividend. 

  • General Reserve: the reserves that are not created for any specific purpose are known as general reserves. It helps in strengthening the financial position and is also known as a contingency reserve. 

  • Capital Reserve: capital reserves are the reserves that are created from the capital profit and which are not used for distributing the dividend. Such reserves are contaminated and kept for preparing that company for any event that can lead to instability, inflammation, or expanding a business.