Reducing Balance Method

Definition of Reducing balance method

Under reducing balance method, the amount of depreciation is calculated by applying a fixed percentage on the book value of the asset each year. In this way, the amount of depreciation each year is less than the amount provided for in the previous year. This is because the book value on the basis of which computation of depreciation expense is based keeps getting reduced from year to year.

Reducing Balance Method Formula


Example (How to calculate depreciation under reducing balance method)

XYZ company purchased a truck for $75,000 on January 1, 2016. It estimates depreciation at 20% per year on book value. Calculate the truck’s depreciation for 20016, 2017, and 2018.

Year 2016:
Book value (original cost for the first year) at the beginning of the year 2016: $75,000
Depreciation for the year 2016: $75,000 × 0.2 = $15,000

Year 2017:
Book value at the beginning of the year 2017: $75,000 – $15,000 = $50,000
Depreciation for the year 2017: $50,000 × 0.2 = $10,000

Year 2018:
Book value at the beginning of the year 2018: $50,000 – $10,000 = $40,000
Depreciation for the year 2018: $40,000 × 0.2 = $8,000

Notice that the depreciation provided in the year 2018 ($8,000) is less than the amount of depreciation provided for in the year 2017 ($10,000), which in turn is less than the amount provided for in the year 2016 ($15,000). The reason is that the rate of depreciation (20% in this case) is being applied to book value, which keeps on reducing each year.

In 2016, the book value was $75,000 while in 2017 it came down to $50,000 and a year later to $40,000. Remember that the rate of depreciation remains the same from year to year but it is applied to a lesser amount (i.e., book value) each year, hence a lower amount of depreciation each year.

Reducing balance method is also known as reducing installment method. It is particularly useful for fixed assets whose value deteriorates faster in their earlier years of usage. Examples of such assets are motors vehicles, smaller machinery, office equipment, etc.

3 thoughts on “Reducing Balance Method”

  1. In 2016 the depreciation is not calculated correct, as 75000-15000 is 60000, not 50000. therefore the depreciation for 2017 will be 12000, not 10000

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