In the business world, investments are often measured by different variables. For instance, a one-time investment of a large purchase, such as buying a new warehouse, would cost a lot up front and could deplete the business’s savings. But that investment would pay off over many years in a number of ways.
The 150 percent declining balance rate is calculated the same way as the straight-line rate, except that the rate is 150 percent of the straight-line rate.
Let’s say our example company purchased a new warehouse for $5 million. That could mean the company has $5 million in expenses during the year they purchase the building. But then the following year there would be no expenses.
Most companies would prefer to spread the cost over several years rather than having to take the cost as an expense all at once. In order to do this, companies depreciate the cost of the item over all the years of its deemed useful life. There are a few ways to calculate depreciation.
The straight-line method is an annual depreciation method calculated by dividing the depreciable base by the service life. The depreciable base is the value that is divided by the service life of the asset. In this example, it’s $5 million, divided by, let’s say, 10 years that the building is estimated to be useful.
The asset’s salvage value is the estimated resale value at the end of its useful life. Salvage value is subtracted from the cost of an asset to determine the amount of the asset cost that will be depreciated.
The straight-line depreciation formula is:
Depreciation = (cost – salvage value) / years of useful life
In our warehouse example, let’s estimate that the salvage value of the building is $1 million. Our formula would look like this:
Depreciation = ($5 million – $1 million) / 10
Depreciation = $100,000
The warehouse would depreciate by 1/10, or 10 percent, each year.
The double declining balance method, or DDB, depreciates an asset more in the early years of the useful span of the asset and less in the later years of the asset’s usefulness. One benefit to using this method is that the company gets a larger benefit from the purchase early on, and it is expected that rising maintenance and repair expenses in later years will offset the declining depreciation.
The DDB is calculated the same way as the straight-line method, except that the rate is 150 percent of the straight-line rate. For instance, if the straight-line depreciation rate is 10 percent and the company uses a 150 percent declining balance rate, the accelerated depreciation rate to be used in the declining balance method will be found by multiplying the straight-line depreciation percentage by 1.5 (150 percent) to find the percentage per year.
.1 x 1.5 = .15, or 15 percent per year.
To calculate this each year, multiply the percentage depreciation per year by the value of the item at the start of the year. For the first year, if the warehouse was worth $5 million, you would multiply $5 million by 0.15 to find you would depreciate it by $750,000.
Subtract the amount of depreciation from the previous value of the item. In this example, you would subtract $750,000 from $5 million to find the new value to be $4,250,000.