Reducing Balance Method

INTRODUCTION TO REDUCING BALANCE METHOD

Reducing balance method is also known as Diminishing Balance and Written Down Value Method. In this method, the rate or percentage of depreciation is fixed instead of amount. The amount of depreciation is charged as a fixed percentage of book or depreciated value for every year. Since, the depreciation is charged at the rate of fixed percentage, the amount continues to diminish in succeeding years. Therefore, it is known as Diminishing Balance Method.This method is suitable for those assets having long life and is subject to addition and extension from time to time, such as land and building, plant and machinery. In this method, the scrap value cannot reach to zero. The scrap value should not be deducted from original value of assets to determine the amount of depreciation.

The following formula are used to calculate amount of depreciation:

R = 1 - \(\sqrt[n]\frac{s}{c}\)

Where,

R = Rate of Depreciation
n = Estimated life of asset
S = scrap value
C = Original Cost of asset

Advantage of Reducing Balance Method

The advantages of reducing balance method are as follows:

• This method is systematic and recognized by taxation authorities.

• This method is suitable for assets having long life such as land and building, plant and machinery.

• This method is able to keep a single account of various assets.

• It minimizes the impact of obsolescence as the larger amount of depreciation is provided in earlier years.

Disadvantage of Reducing Balance Method

The disadvantages of reducing balance method are as follows:

• This method cannot be applied for the assets that have quite short life.

• It puts too much emphases on historical continuous.

• It ignores interest on capital invested in fixed assets as in straight line method.

• This method lacks simplicity as it is difficult to decide the rate of percentage.

Method of Recording Depreciation

The following journal entries are passed while keeping the record of depreciation:

1. For assets purchases:

Assets a/c…………………….Dr
To Bank a/c

2. For depreciation charged at the end of year:

Depreciation a/c………………….Dr
To Assets a/c

3. For transfer of depreciation to Profit and Loss Account:

Profit and Loss a/c……………………….Dr
To Depreciation a/c

4. For assets sold:

Bank a/c……………………….Dr
To Assets a/c

5. For gain on sale of assets:

Assets a/c…………………….Dr
To Profit and Loss a/c

6. For loss on sale of assets:

Profit and Loss a/c……………….Dr
To Assets a/c

ILLUSTRATION 1:

A machine purchases for Rs.40000 and its scrap value if Rs. 10480 and the useful life of the machine is 6 years.
Required:

Rate of depreciation under diminishing balance method and amount of depreciation for three years.

Solution

Given, Cost of price of asset (C) = Rs.50000
Scrap Value (S) = Rs.10000
Useful life of asset (n) = 5 years
Rate of depreciation (R) = ?

Now,

R = 1 - \(\sqrt[n]\frac{s}{c}\)

=1 - \(\sqrt[6]\frac{10480}{40000}\)

= 1 - \(\sqrt[6]{0.262}\)

= 1 – 0.8 (by using log)

= 0.2

Hence,

Rate of Depreciation = 0.2 × 100
= 20 %

Depreciation for 1^st year = 40000 × 0.2

= Rs. 8000

Depreciation for 2^nd Year = (40000 – 8000) × 0.2

= Rs. 6400

Depreciation for 3^rd Year = (40000 – 8000 – 6400) × 0.2

= Rs. 5120

ILLUSTRATION 2:

A Company purchased furniture for Rs. 75000 and spent Rs. 5000 on its transportation and installation on 1^stSharwan, 2065. Depreciation is charge @ 10% per annum on diminishing balance method.

Required: Furniture account for first three years

Machinery a/c

References:

Sharma, Narendra et.al., Principles of Accounting-XI, Bundipuran Prakashan, Kathmandu

Koirala, Yadav Raj et.al., Principles of Accounting-XI, Asmita Books Publication, Kathmandu

Shrestha, Dasharaha et.al., Accountancy-XI, M.K. Prakashan, Kathmandu