What is written down value method of depreciation?

The written down value method of depreciation is a widely used accounting technique to gradually allocate the costs of an asset over its useful life. Also known as the diminishing balance method or the reducing balance method, it allows businesses to account for the wear and tear or obsolescence of an asset over time.

The written down value method of depreciation calculates the annual depreciation expense by applying a fixed percentage to the remaining net book value of the asset each year.

This technique assumes that an asset is most useful and productive in its early years and loses value as time passes. By using a fixed annual depreciation rate, the value of the asset is reduced each year, thus reflecting its decreasing worth on the company’s balance sheet.

Here is an example to illustrate the written down value method of depreciation:

Let’s say a company purchases a computer system for $10,000, with an expected useful life of five years and zero residual value. In this case, the depreciation rate would be 20% (100% divided by the useful life of five years).

Using the written-down value method, the annual depreciation expense would be calculated as follows:

• Year 1: $10,000 x 20% = $2,000
• Year 2: ($10,000 – $2,000) x 20% = $1,600
• Year 3: ($10,000 – $2,000 – $1,600) x 20% = $1,280
• Year 4: ($10,000 – $2,000 – $1,600 – $1,280) x 20% = $1,024
• Year 5: ($10,000 – $2,000 – $1,600 – $1,280 – $1,024) x 20% = $819.20

As seen in the example, each year the depreciation expense is calculated based on the remaining net book value of the computer system. The depreciation expense gradually decreases over time as the asset is used and its value diminishes.

FAQs about the written down value method of depreciation:

1. What is the difference between the written down value method and the straight-line method of depreciation?

The written down value method allows for faster depreciation in the initial years of an asset’s life while the straight-line method evenly allocates depreciation over the useful life of the asset.

2. Why is the written down value method popular?

It aligns better with the actual decrease in an asset’s value over time and provides larger depreciation deductions in the earlier years, resulting in tax advantages for businesses.

3. Can the written down value method be used for tax purposes?

Yes, many countries allow businesses to use this method for tax calculations, as long as it aligns with the applicable tax laws and regulations.

4. Does the written down value method require a residual value for the asset?

No, it is not necessary to have a residual value for the asset. Some businesses may assume a zero residual value for simplicity.

5. Can the depreciation rate be changed over time?

Yes, businesses can change the depreciation rate during an asset’s useful life based on their analysis of its actual decline in value.

6. Does the written down value method result in a lower or higher net income for the company?

Using the written down value method, the depreciation expense is higher in the earlier years, resulting in lower net income for the company.

7. How does the written down value method affect a company’s balance sheet?

The method reduces the value of the asset over time, which is reflected in the balance sheet as a decrease in the net book value of the asset.

8. Are there any limitations or drawbacks to using the written down value method?

One limitation is that it might not reflect the actual decrease in value accurately in all cases. Additionally, it can be more complicated to calculate compared to the straight-line method.

9. Is the written down value method acceptable under international accounting standards?

Yes, the International Financial Reporting Standards (IFRS) recognize the written down value method as an acceptable way to calculate depreciation.

10. Can the written down value method be used for intangible assets?

Yes, the method can be used for intangible assets, such as patents or trademarks, that have a definite useful life.

11. How does the written down value method affect the taxes a business pays?

Using this method, businesses can claim higher depreciation expenses in the earlier years, which can reduce their taxable income and correspondingly lower their tax liabilities.

12. Can the written down value method be used for assets that appreciate in value?

No, the written down value method is suitable for assets that decline in value over time. For appreciating assets, a method such as the revaluation model may be more appropriate.

In conclusion, the written down value method of depreciation is a practical and commonly used accounting technique that allows businesses to allocate the costs of assets and reflect their decreasing value over time. It provides a more accurate representation of an asset’s decline in worth and often offers tax advantages for businesses.

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