Depreciation is the amount that an asset loses in value each year from its historical cost, or the amount that you paid for it. Determining the depreciation of an asset can help you more accurately determine what the value of your assets or your company is.

As an investor, if you understand what depreciation calculation method companies that you are considering investing in are using, then you can better understand what the actual current value of the company is.

Different methods of computing depreciation lead to different measurements of the value of a company; double declining balance, in contrast to straight line depreciation, is often considered to be a more accurate measure of the present value of an asset.

Declining-balance method

There are two types of depreciation calculation methods: accelerated depreciation and straight-line depreciation.

• Straight-line depreciation assumes the same amount of depreciation each year on an asset.
• Accelerated depreciation is a method of calculating depreciation that assumes that you will see a higher rate of depreciation earlier in the depreciable life of an asset.

Accelerated depreciation is a method of calculating depreciation that is seen by some as a more accurate measure of the actual resale value of an asset. Accelerated depreciation is also seen by many as a more accurate way to measure what the actual resale value of an asset will be at any given time. This is true for the simple reason that the majority of assets are worth more right when they're bought. It's well-known that a brand new car loses value as soon as you drive it off the lot, and will lose value rapidly in the first few years.

When you use declining-balance depreciation, what you do is base the depreciation of each period-year, quarter, etc.-on the net book value of the previous year, combined with the estimated useful life of an asset and a factor. This factor is usually two; when the factor is two, then the method is called double declining-balance.

The formula for declining-balance depreciation is as follows:

Depreciation expenses = previous period NBV x factor/N

You calculate the depreciation for each year until you reach the previously determined salvage value of the asset, or the end of the previously determined useful life of the asset.

One important thing to keep in mind when it comes to double declining-balance depreciation is that it might not end up fully depreciating an asset by the end of the asset's life. If this ends up being the case with a particular asset, then you might end up using a method that simultaneously computes a straight-line depreciation for each year.

Then the larger of the two depreciations will end up being applied to the asset.

In other words, halfway through the life of an asset, you will convert your depreciation calculations from double declining balance depreciation to straight line depreciation.

Why to use double declining depreciation

Using double declining depreciation calculation methods can be useful for a company when you are determining the various charges that are made to your income. With double declining depreciation, as the years go by, you will end up charging less and less of a depreciation expense because the majority of the depreciation expenses were calculated at the beginning of the life of the asset.

To balance the decreasing depreciation expenses, you will probably be paying more for maintenance of a machine or other asset. Maintenance expenses go up, depreciation expenses go down, and the balance sheet ends up staying the same.