Diminishing Balance Method of Depreciation

TORAN LAL VERMA

The Diminishing Balance Method of depreciation, also known as the Declining Balance Method or Written Down Value (WDV) method, is one of the most commonly used depreciation methods in India. It recognizes that assets tend to lose their value more rapidly in the earlier years of their useful life and slower in the later years. This method reflects this pattern by charging a higher depreciation expense in the initial years and a decreasing amount in subsequent years. Let’s delve into the details of this method with Indian examples.

How the Diminishing Balance Method Works:

The formula for calculating depreciation using the Diminishing Balance Method is as follows:

Depreciation Expense = (Opening Book Value * Depreciation Rate)

Where:

  • Opening Book Value: The value of the asset at the beginning of the year.
  • Depreciation Rate: A fixed percentage rate determined based on the asset’s expected useful life and other factors.

Key Features of the Diminishing Balance Method:

  1. Front-Loaded Depreciation: This method results in higher depreciation expenses in the early years of an asset’s life and lower expenses as the asset ages. It aligns with the idea that assets are more valuable when they are newer and gradually lose their value over time.
  2. Depreciation Rate: The depreciation rate is usually twice the straight-line depreciation rate. For example, if an asset has a 10% straight-line depreciation rate, it might have a 20% diminishing balance depreciation rate.
  3. Book Value: The asset’s book value decreases each year by the depreciation expense. The book value at the beginning of each year is used to calculate the depreciation for that year.

Indian Examples:

Let’s explore a few Indian examples to better understand the Diminishing Balance Method:

Example 1: Machinery in a Manufacturing Company

Suppose an Indian manufacturing company purchases machinery for ₹10,00,000 with a diminishing balance depreciation rate of 25%. Here’s how the depreciation would be calculated:

  • Year 1: ₹10,00,000 * 25% = ₹2,50,000
    • Book Value at the end of Year 1: ₹10,00,000 – ₹2,50,000 = ₹7,50,000
  • Year 2: ₹7,50,000 * 25% = ₹1,87,500
    • Book Value at the end of Year 2: ₹7,50,000 – ₹1,87,500 = ₹5,62,500

And so on for subsequent years.

Example 2: Vehicle in a Transportation Company

Consider an Indian transportation company that purchases a vehicle for ₹5,00,000 with a diminishing balance depreciation rate of 30%. The calculation proceeds as follows:

  • Year 1: ₹5,00,000 * 30% = ₹1,50,000
    • Book Value at the end of Year 1: ₹5,00,000 – ₹1,50,000 = ₹3,50,000
  • Year 2: ₹3,50,000 * 30% = ₹1,05,000
    • Book Value at the end of Year 2: ₹3,50,000 – ₹1,05,000 = ₹2,45,000

And so forth for subsequent years.

Conclusion:

The Diminishing Balance Method of depreciation is widely used in India because it reflects the actual wear and tear of assets more accurately, especially for assets that lose value rapidly in their early years. It results in higher depreciation expenses initially, which can be beneficial for reducing taxable income and tax liability. However, it’s essential for businesses to carefully consider the method they use and adhere to relevant accounting and tax regulations in India.

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