L’declining balance depreciation is an advantageous accounting method allowing companies to optimize their financial management. This accelerated depreciation technique offers numerous tax and economic advantages. Let’s find out together how to calculate and apply this method, its particularities and its benefits for businesses.
What is declining balance depreciation and what are its advantages?
L’declining balance depreciation is an accounting method which allows the cost of acquiring an asset to be distributed over its useful life. Unlike straight-line depreciation, this technique applies a higher depreciation rate in the first few years, then decreasing over time.
The advantages of declining balance depreciation are numerous:
- Tax optimization: allows you to reduce the taxable base in the first years
- Better representation of the real depreciation of the property
- Encouragement for investment and modernization of the equipment fleet
- Improvement of the company’s cash flow
This method is particularly suitable for assets undergoing strong initial depreciation, such as computer equipment or vehicles. It allows businesses toalign their accounting with the economic reality of their investments.
To benefit from decreasing depreciation, the assets must meet certain criteria. In particular, they must have a useful life of more than three years and be acquired or manufactured from January 1, 1960. This method mainly applies to depreciable fixed assets used for industrial, commercial or artisanal activities.
How to calculate the declining balance depreciation rate?
The calculation of decreasing depreciation rate is done in several stages. First of all, it is necessary to determine the linear depreciation rate corresponding to the normal useful life of the asset. Then, this rate is multiplied by a coefficient which varies depending on the depreciation period:
| Depreciation period | Coefficient |
|---|---|
| 3 or 4 years | 1.25 |
| 5 or 6 years old | 1.75 |
| More than 6 years | 2.25 |
For example, for an asset with a depreciation period of 5 years, the linear rate would be 20% (100% / 5 years). The decreasing depreciation rate would then be 20% x 1.75 = 35%.
It is important to note that the rate thus obtained applies each year to the residual value of the property, that is to say at its original value less depreciation already carried out. This method allows for faster depreciation in the first years, better reflecting the loss of real value of certain assets.
Steps for calculating and applying declining balance depreciation
The calculation of thedeclining balance depreciation takes place in several stages:
- Determine the depreciable base (generally the acquisition cost of the property)
- Calculate the declining balance depreciation rate
- Apply this rate to the residual value of the property each year
- Switch to straight-line depreciation when it becomes more advantageous
Let’s take the example of an industrial machine purchased for €100,000 with a useful life of 5 years. The declining depreciation rate would be 35% (20% x 1.75). Here is how the amortization table would look:
| Year | Residual value | Depreciation | Net book value |
|---|---|---|---|
| 1 | €100,000 | €35,000 | €65,000 |
| 2 | €65,000 | €22,750 | €42,250 |
| 3 | €42,250 | €14,788 | €27,462 |
| 4 | €27,462 | €13,731 | €13,731 |
| 5 | €13,731 | €13,731 | €0 |
We see that the depreciation is greater in the first years, then gradually decreases. From the 4th year, we switch to linear depreciation because it becomes more advantageous (the asset is depreciated equally over the last two years).
Practical considerations and special cases
The application of thedeclining balance depreciation requires particular attention to certain practical aspects and specific cases:
Pro rata temporis : If the property is acquired during the year, the first annual depreciation payment must be calculated in proportion to the time elapsed between the date of acquisition and the end of the accounting year.
Assets built by the company : For fixed assets produced by the company itself, the depreciable base corresponds to the production cost, including direct costs and a share of indirect production costs.
Change of method : A company can opt for declining balance depreciation even if it previously practiced straight-line depreciation. On the other hand, this change must be justified and applied consistently.
It is essential to take into account the tax specificities linked to decreasing depreciation. For example, certain goods, such as passenger vehicles, may be subject to tax deductibility limitations.
Finally, declining balance depreciation is a valuable tool for companies wishing to optimize their financial and tax management. This method, although more complex to implement than straight-line depreciation, offers significant advantages in terms of cash flow and faithful representation of asset depreciation. A good understanding of its mechanisms and its application allows companies to take full advantage of its benefits, while respecting the accounting and tax rules in force.