The other names for reducing balance methods are declining balance and diminishing balance. In this particular type of depreciation, a flat rate of depreciation is charged to the net book value of the fixed asset. Under this approach in the early years of the useful life of assets more depreciation is charged and in the subsequent year, depreciation is low. Diminishing balance is appropriate for such assets which have higher utilization in the early years. Just like computer equipment which works with better functionality in early years so it is obvious that they will depreciate more in those years.
Example:
The financial year of ABC ltd. is 1st Jan- 31Dec. On 5th April Company purchased a machine at price of $15000, the depreciation rate is 20% reducing balance and in the year of purchase full depreciation will be charged. Calculate the depreciation expense for the first three years.
| Year | Depreciation rate | Net Book Value | Depreciation Expense |
| 1 | 20% | 15000 | 3000 (15000*20%) |
| 2 | 20% | 12000 | 2400 (12000*20%) |
| 3 | 20% | 9600 | 1920 (9600*20%) |
Straight line method
Straight line method of depreciation is a widely used method and it is a rather simple method. In this type you just have to allocate the cost of the asset over its useful life.
The formula to calculate the depreciation is (cost of the asset -salvage value)/useful life.
Example.
Company XYZ ltd bought a car for $22000 and the expected useful life is 6 years and the salvage value after six years would be $4000. Calculate the depreciation using the straight line method.
Depreciation expense= (22000-4000)/6
= $3000