We?ll start with straight-line depreciation, as the double-declining
balance is based upon it. But there?s an important disclaimer here:
we assume that we know the salvage value at the end ? so it reduces
the depreciable amount by $10,000.
More often real-world finance problems assume no salvage value ?
because it?s so hard to predict. Then tooling is depreciated over its
expected life ? and any salvage value simply comes back in the last
And another disclaimer: the IRS has a half-year convention for
equipment put in place ? but since we?re using the full-year in this
problem, we?ll ignore that too.
$90,000 over 4 years, so it?s 25% per year ? and I?ve bracketed them
as negative numbers.
Double-declining balance doubles the remaining depreciation each year
? until the point that it is less than straight-line, then it reverts
to straight-line for the balance of the asset.
?Double declining balance depreciation method?
So, 2005 is $90,000 * 0.50 = ($45,000). This leaves $45,000 left to
be depreciated in future years.
2006 is 0.50 * $45,000 = ($22,500). This leaves $22,500 left to be
depreciated in future years.
2007 is 0.50 * $22,500 ? but that?s now less than straight line of
($22,500) ? so we?ll take the full balance this year.
2008: no depreciation
IMPACT ON NET INCOME: Obviously the double-declining balance reduces
net income. But remember what these depreciation amounts are: they?re
estimates of the value of an investment. Accelerated depreciation
methods like double-declining balance or MACRS (used in current IRS
calculations) are tax allowances meant more to stimulate investment
than reflect equipment wear-and-tear.
And most importantly, depreciation doesn?t use cash ? it just reduces
earnings on paper.
IMPACT OF TAXES: Taxes DO reduce cash in the bank. That reduces money
available for bonuses to managers or to pay shareholders in dividends.
So, in any tax situation, faster depreciation actually increases the
amount of cash available by reducing taxes.
At current U.S. tax rates, with a maximum tax rate of 35%, choosing
double-declining balance would save Balls and Bats $7,875 in taxes for
2005, money that can be reinvested or returned as dividends or
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