Use of salvage value in declining balance depreciation methods
November 29, 2012
Declining balance methods of depreciation, specifically the double-declining balance method, do not take into consideration the salvage value of an asset when determining the depreciable basis. Some people wonder why that is the case. This article provides the answer.
Letís start by recalling what depreciation is.
Depreciation is the allocation of the cost of property, plant, and equipment to expenses over their useful (economic) life in a systematic and rational manner.
Depreciation should generally be based on the cost of an asset reduced by its estimated salvage value.
Salvage value is a portion of a fixed asset cost that is expected to be recovered at the end of its useful life.
In many cases the salvage value of the asset will be zero or will be so small that it would not be considered in calculating the depreciable basis (i.e., amount allocated to expenses as depreciation). However, in certain instances the salvage value may be significant and thus should be considered in calculating depreciation expense.
There are multiple depreciation methods. The most common method used in financial accounting is the straight-line depreciation method.
Straight-line depreciation is a depreciation method in which periodic depreciation is the same for each period of the asset useful life. Straight-line depreciation is calculated by dividing the depreciable cost (i.e., cost less salvage value) by the number of periods in the asset useful life.
Another method is the declining balance depreciation method.
Declining balance depreciation produces a decreasing annual depreciation expense over the useful life of an asset. The periodic depreciation is based on the declining book value of the asset and is calculated by multiplying the beginning net book value of the asset by the declining balance depreciation rate. Salvage value is not considered in calculating the depreciable basis of the asset.
A common rate used in the declining balance depreciation method is double the straight-line rate, and the method where this double declining rate is used is called the double-declining balance method.
If youíve noticed above, the salvage value is used to determine the basis to which depreciation rate is applied under the straight-line depreciation method, but it is not used to determine the basis under the declining balance method. Why is that? Letís look at the depreciation expense calculation using both methods and find the answer.