What is depreciation?
Depreciation is the act of writing off an asset’s value over its expected useful life, and reporting it on IRS Form 4562. The double declining balance method of depreciation is just one way of doing that. Double declining balance is sometimes also called the accelerated depreciation method. Businesses use accelerated methods when having assets that are more productive in their early years such as vehicles or other assets that lose their value quickly.
If you’re brand new to the concept, open another tab and check out our complete guide to depreciation. Then come back here—you’ll have the background knowledge you need to learn about double declining balance.
Double declining balance vs. the straight line method
The most basic type of depreciation is the straight line depreciation method. You use it to write off the same depreciation expense every year. So, if an asset cost $1,000, you might write off $100 every year for 10 years. Your annual depreciation amount never changes.
On the other hand, with the double declining balance depreciation method, you write off a large depreciation expense in the early years, right after you’ve purchased an asset, and less each year after that. So the amount of depreciation you write off each year will be different.
The double declining balance formula
Double declining balance is calculated using this formula:
2 x basic depreciation rate x book value
Basic depreciation rate
Your basic depreciation rate is the rate at which an asset depreciates using the straight line method.
To get that, first calculate:
Cost of the asset / recovery period
Cost of the asset is what you paid for an asset. Recovery period, or the useful life of the asset, is the period over which you’re depreciating it, in years.
Once you’ve done this, you’ll have your basic yearly write-off. You can use this to get your basic depreciation rate.
Basic yearly write-off / cost of the asset
The result is your basic depreciation rate, expressed as a decimal. (You can multiply it by 100 to see it as a percentage.) This is also called the straight line depreciation rate—the percentage of an asset you depreciate each year if you use the straight line method.
Book value
Every year you write off part of a depreciable asset using double declining balance, you subtract the amount you wrote off from the asset’s book value on your balance sheet. Starting off, your book value will be the cost of the asset—what you paid for the asset.
That number goes down each year, as you subtract the amount you wrote off.
When accountants use double declining appreciation, they track the accumulated depreciation—the total amount they’ve already appreciated—in their books, right beneath where the value of the asset is listed. If you’re calculating your own depreciation, you may want to do something similar, and include it as a note on your balance sheet.
Confused yet? Don’t worry—these formulas are a lot easier to understand with a step-by-step example.
The benefits of double declining balance
There are a few benefits to the double depreciation method.
You can match maintenance costs
Some depreciable assets—vehicles, for instance—work smoothly when you first buy them, but require more maintenance over time. Luckily, that maintenance is tax-deductible. Double declining depreciation lets you get a bigger tax write-off in the earlier years, when you aren’t writing off maintenance costs.
In later years, as maintenance becomes more regular, you’ll be writing off less of the value of the asset—while writing off more in the form of maintenance. So your annual write-offs are more stable over time, which makes income easier to predict.
You can cover more of the purchase cost upfront
You get more money back in tax write-offs early on, which can help offset the cost of buying an asset. If you’ve taken out a loan or a line of credit, that could mean paying off a larger chunk of the debt earlier—reducing the amount you pay interest on for each period.
You can reduce your tax obligation when it counts
Some assets make you more money right after you buy them. (An example might be an apple tree that produces fewer and fewer apples as the years go by.) Naturally, you have to pay taxes on that income. But you can reduce that tax obligation by writing off more of the asset early on. As years go by and you deduct less of the asset’s value, you’ll also be making less income from the asset—so the two balance out.
The drawbacks of double declining depreciation
Like anything else, double declining balance has its downsides.
You’ll have to do more math, or get an accountant’s help
Bottom line—calculating depreciation with the double declining balance method is more complicated than using straight line depreciation. And if it’s your first time filing with this method, you may want to talk to an accountant to make sure you don’t make any costly mistakes.
Your income may become harder to predict
If you make estimated quarterly payments, you’re required to predict your income each year. Since the double declining balance method has you writing off a different amount each year, you may find yourself crunching more numbers to get the right amount. You’ll also need to take into account how each year’s depreciation affects your cash flow.
You may regret taking more money upfront
If something unforeseen happens down the line—a slow year, a sudden increase in expenses—you may wish you’d stuck to good old straight line depreciation. While double declining balance has its money-up-front appeal, that means your tax bill goes up in the future. That can be tough if the extra money is sorely needed.
Example of the double declining balance method
So, you just bought a new ice cream truck for your business. Congratulations! Now you’re going to write it off your taxes using the double depreciation balance method.
The truck cost $30,000. Under IRS rules, vehicles are depreciated over a 5 year recovery period.
Step one
Figure out the basic yearly write-off for the truck.
30,000 / 5 = $6,000
Step two
Figure out the straight-line rate of depreciation for the truck.
6,000 / 30,000 = 0.2 (or 20%)
Step three
Calculate the book value of the truck.
(Each year, you subtract the amount you depreciated over previous years from the book value. This is our first year of depreciating this asset, though, so it won’t change.)
30,000 – 0 = $30,000
Remember to do this step every year.
Step four
Enter the straight line depreciation rate in the double declining depreciation formula, along with the book value for this year.
(2 x 0.2) x (30,000) = $12,000
In the first year of service, you’ll write $12,000 off the value of your ice cream truck. It will appear as a depreciation expense on your yearly income statement.
Remember—you need to recalculate the book value every year. So you might as well make a note now:
30,000 – 12,000 = $18,000
Next year when you do your calculations, the book value of the ice cream truck will be $18,000.
How to plan double declining balance depreciation
For the second year of depreciation, you’ll be plugging a book value of $18,000 into the formula, rather than one of $30,000.
We won’t show the math here. But, spoiler warning: in the second year, you’ll write off $7,200. That will also be subtracted from the $18,000 book value, bringing it down to $10,800 in the third year.
To create a depreciation schedule, plot out the depreciation amount each year for the entire recovery period of an asset.
Three things to note:
1- You can’t use double declining depreciation the full length of an asset’s useful life. Why? Since it always charges a percentage on the base value, there will always be leftovers.
Here’s an example. Let’s say you have a bottle of really nice wine. You want to make it last, so you resolve to only drink half of the wine each day. On Monday you drink half the bottle. On Tuesday, you drink half of what’s left.
By Wednesday, you have one quarter of a bottle left. So, you drink half of that. On Thursday, you have one eighth left, and you drink half of that—so you’ve only got one sixteenth left for Friday. And so on—as long as you’re drinking only half (or 50%) of what you have, you’ll always have half leftover, even if that half is very, very small.
2- Eventually, you’ll have to switch from double declining depreciation to the straight line method. It’s the only way to make sure you depreciated the entire value of an asset—or “drink all of the wine.”
Typically, accountants switch from double declining to straight line in the year when the straight line method would depreciate more than double declining. For instance, in the fourth year of our example, you’d depreciate $2,592 using the double declining method, or $3,240 using straight line. That’s when you’d make the switch.
3- Once it’s fully depreciated, you list the asset’s salvage value on the books. After an asset is fully depreciated, its book value doesn’t become $0. Instead, it becomes that asset’s salvage value. The salvage value is the fair market price of an asset after the end of its useful life.
Say your ice cream truck cost $30,000 brand new. After a five year recovery period, you’ve completely written it off. Doing some market research, you find you can sell your five year old ice cream truck for about $12,000—that’s the salvage value. So the truck’s book value is now $12,000.
To get a better grasp of double declining balance, spend a little time experimenting with this double declining balance calculator. It’s a good way to see the formula in action—and understand what kind of impact double declining depreciation might have on your finances.
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Ready to file your taxes? Learn how to report depreciation, one step at a time, with our guide to Form 4562.
