UNIT 3:

BRS AND DEPRECIATION

Bank reconciliation statement: A form that allows individuals to compare their personal bank account records to
the bank's records of the individual's account balance in order to uncover any possible discrepancies.
Since there are timing differences between when data is entered in the banks systems and when data is entered in the
individual's system, there is sometimes a normal discrepancy between account balances. The goal of reconciliation is to
determine if the discrepancy is due to error rather than timing.
f there is a dispute between two friends, or they fail to agree about some matter, the disagreement may temporarily end the
friendship between them. When they become friends again we say they have 'reconciled' with one another. Reconciliation is,
therefore, resuming of friendly relations as a result of reasonable explanations between them.

In business, we often have sets of figures (balances of cash book and pass book) which apparently disagree with one another, but
reasonable explanations for the disagreement will reconcile the two sets of figures and show that, in fact both are right.

There are three reasons why the balances of cash book and pass book do not agree. These are given below:

1. One party may lack the knowledge of the transactions recorded by the other.
2. There is always an unavoidable delay between one party doing something and the other party knowing about it.
3. Errors and mistakes often occur.

Any discrepancy between the balance of cash book and that of pass book, the depositor prepares a statement to explain the causes of
discrepancies and to reconcile the two balances. This statement of explanation is called bank reconciliation statement.

The purpose of this statement is to discover the various things the bank has done in the pass book which the cashier was not aware
of, put right any thing that is wrong and draw up a logical explanation of the remaining differences, which are not wrong, but are
delayed from being right by the time lag.

Bank reconciliation statement is generally prepared at the end of the month or the year and it is not necessary when there is no
disagreement between the pass book balance and the cash book balance. One copy of this statement is also sent to the bank if the
bank has made some errors or mistakes in the pass book.

The great advantage of preparing this statement is, if by mistake the pass book balance is shown less, the bank may wrongly
dishonor our checks for insufficiency of funds. As a result, the goodwill of the business will be suffered and our creditors will refuse
to accept our checks in future. By preparing this statement true bank balance can be ascertained.

Read our high quality articles about "bank reconciliation statement" topic:

Preparing Bank Reconciliation Statement:

Recording in Cash Book:

In businesses, the bank account is usually kept in cash book - as a part of the three column cash book, i.e. bank account in the cash
book means two bank columns on the both sides of two column or three column cash book. It is made up everyday, and we record
in it all checks received from our debtors and all checks issued to our creditors or suppliers. We shall also have several contra
entries every month, recording excess cash paid in or cash drawn out when required for use in business. At the end of the month, the
cash book (bank column) is balanced and the result is a bank balance (as per cash book). Thus the cash book (bank columns) tells
us, what is our balance with the bank on a particular date.

Recoding in Pass Book:

The bank also keeps a record of our bank account with the title "depositor's account" and enters into our account everyday what is
paid in and what is drawn out. At the end of any day, bank will gladly tell us our bank balance (as per bank record). So two
reciprocal accounts are kept i.e., bank account (bank column in the cash book) in the books of depositor and depositor's account in
the books of the bank. The balances shown by the two accounts (bank account and depositor's account) should be equal because
when the bank account is debited, the depositors account is credited by the bank and vice versa. In other words, for each transaction
opposite entries are made in two books. So if the bank column of the cash book shows a credit balance the depositor's account will
show a debit balance in the books of bank.

Usually a copy of depositor's account is provided by the bank to the depositor, which is called 'pass book'. This book is written by
the bank. After suitable intervals the depositor submits the pass book to the bank and the bank in turn returns it to the depositor after
recording the transactions there in.

Bank Statement as an Alternative Source to Pass Book:

Sometimes, instead of providing a pass book to the depositor, at certain intervals, usually monthly, the bank sends each depositor a
'bank statement', which is a record of the beginning balance, any increase and decrease that have occurred since the previous
statement and the ending balance of the depositor's account with the bank. The pass book and bank statement serve the same
purpose to the depositor.

Rules for Preparing Bank Reconciliation Statement:

The statement must be given a proper heading. The statement is usually prepared at the end of the month or year, so the heading will
be given in the following way:

Name of Business
Bank Reconciliation Statement
As on 31st Jan...........

Bank reconciliation statement may be started with either cash book balance or pass book balance. If it is started with cash book
balance, it will be finished with pass book balance and if it is started with pass book balance, it will be finished with cash book
balance.

After heading, the balance given to us should be written in the following way:
Balance as per cash book or pass book XXX

The causes of disagreement are added with or deducted from the starting balance to get balance of the other book.

Usually the cash book shows a debit balance (a favorable balance for depositor) and the pass book shows a credit balance (a
favorable balance for depositor).

The bank reconciliation statement is a statement showing causes of disagreement between the cash book balance and pass book
balance on a specific date, so while preparing it only those items should be considered which cause disagreement up to that specific
date. For example, a checks for $2,000 were sent to bank for collection on 20th December, out of these $1,100 were collected and
credited by the bank up to 31st December. The statement was prepared on 31 December. The collected checks were only $1,100 and
un-collected checks were $900 which caused disagreement between two balances, so checks for $900 (being not collected) were
considered only while preparing the bank reconciliation statement.

Example:

From the following particulars, prepare a bank reconciliation statement of Mr. N as on 31st December 2005.
1. Balance as per cash book (Dr.) $64,000
2. Checks deposited but not yet collect $40,400
3. Checks issued but not yet paid by bank $26,000
4. Interest credited by bank but not recorded in cash book. $500
5. Bank charges debited by bank but not entered in cash book $100

Solution:
Mr. N
Bank Reconciliation Statement
As on 31st Jan...........
$ $
Bank balance as per cash book Dr. 64,000
Less:
Checks deposited but not yet collected by the bank 40,400
Bank charges debited in pass book 100 40,500

23,500

Add:
Checks issued but not yet paid by the bank 26,000
Interest credited by the bank in pass book 500 26,500

Ans: The balance as per pass book Cr. 50,000

If the statement is started with pass book balance:

Mr. N
Bank Reconciliation Statement
As on 31st Jan...........
$ $
The balance as per pass book Cr. 50,000
Less:
Checks issued but not yet paid by the bank 26,000
Interest credited by the bank but not entered in the pass book 500 26,500

23,500

Add:
Checks deposited but not yet collected by the bank 40,400
Bank charges debited but not entered in the cash book 100 40,500
 Ans: Bank balance as per cash book Dr. 64,000

It may be noted from the above two statements that the causes of disagreement which are added in the first method are deducted in
the second method.

Explanation of Difference:

Cash book is written by depositor and pass book is written by the bank. All transactions related to bank are recorded in the bank
column of the cash book and these transactions are also recorded in the pass book by the bank. Following are the main points of
difference between cash book and pass book:
Cash Book Pass Book
1. It is written by the depositor. 1. It is written by the bank but remains in the depositor's
possession.
2. Money deposited is recorded on the debit side and 2. Money deposited is entered on the credit side and withdrawn
money withdrawn on credit side. on the debit side.
3. A check deposited for collection is recorded on the 3. It is recorded on the date when it is actually collected from
date of deposit. the debtor's bank.
4. A check when issued to a creditor is recorded on the 4. It is recorded when it is paid by the bank to the creditor.
date of issue.
5. Its debit balance shows cash at bank and credit 5. Its debit balance shows bank overdraft and credit balance
balance shows bank overdraft. shows cash at bank.

Examples are always the best way to understand. Consider the following example:

Example:

Enter the following transactions in the cash book and pass book:
Jan.
$
2005
1. Mr. X opened a current account with Standard Chartered Bank. 80,000
3. Paid Mr. N by check. 8,000
5. Received a check from Mr. S and deposited into the bank. 16,000
8. Withdrew from bank for office use. 6,000
10. Paid rent by check. 10,000
14. Bank charges debited by bank 400
17. Paid Mr. Z by check 3,000

Solution:

Cash Book (bank column only)

Date Particulars V/N L/F Bank Date Particulars V/N L/F Bank
1.1.05 Cash A/C C 80,000 3.1.05 Mr. N A/C 7 8,000
Mr. S A/C 5 16,000 8.1.05 Cash A/C C 6,000
10.1.05 Rent A/C 9 10,000
 14.1.05 Bank Charges A/C 11 400
17.1.05 Mr. Z A/C 13 3,000
68,600

68,600 68,600

Pass Book (A copy of depositor's account in banks ledger)

Balance
Debit Credit
Date Particulars
(withdrawals) (deposits)

1.1.05 Cash 80,000 80,000

3.1.05 (Mr. N) Check No....... 8,000 72,000
5.1.05 (Mr. S) Check No....... 16,000 88,000
8.1.05 Cash: Check No....... 6,000 82,000
10.1.05 Check No.......paid 10,000 72,000
14.1.05 Bank charges 400 71,600
17.1.05 (Mr. Z) Check No....... 3,000 68,600

It may be noted that the cash book is showing a debit balance (cash at bank) or $68,600 and the pass book (depositor's A/C) is
showing a credit balance of $68,600. Both balances are equal but opposite generally these two balances do not agree. To understand
the reasons of disagreement,

Causes of disagreement between cash book and pass book

Checks Issued or Drawn to Creditors But Not Paid by Bank:

When a check is issued to a creditor, it is recorded on the credit side of the cash book in bank column. The bank will record it on the
date when it is paid. In most of the cases a check cannot be presented for the payment by the creditor on the date on which it is
drawn. So long the check is not presented to the bank, the cash book balance and the pass book balance will differ.

Checks Deposited for Collection But Not Yet Collected and Credited by the Bank:

When a check is received from a debtor, it is recorded in the cash book on the date when it is deposited with the bank for collection.
But the bank will record it in depositor's account on the ate when it is actually collected by the bank from the concerned bank. So
long the bank cannot collect the amount, the cash book balance and pass book balance will disagree.

Amount Deposited Directly into the Bank by Debtors:

Sometimes the debtors deposit the amount directly to our bank a/c instead of paying cash to us. In such a case the bank will transfer
the amount to our account and sends us an intimation of this transaction. But usually, there is some delay in receiving this
information from the bank. So long the intimation is not received by us, the cash book balance and the pass book balance will
disagree. For this, the cash book will show less balance and the pass book will show more balance.

Income Collected by the Bank:

Sometimes the bank collects and credits our account with dividend on shares, interest on govt. securities etc. as per our instructions
and sends an intimation to us. But it takes a few days to receive this intimation from the bank and we record it in cash book on the
date of receipt of this intimation. For this, the cash book will show less balance and the pass book will show more balance.

Interest on Deposits:

The bank allows us interest on our deposits and credits the amount of interest to our account and sends intimation to us On receipt of
the intimation, we record it in the cash book. So long the information is not received by us, the cash book balance and the pass book
balance will not agree. For this, the cash book will show less balance and pass book will show more balance.

Expenses Paid by the Bank Directly:

Sometimes the bank pays insurance premium, factory rent, interest on debentures, trade subscription etc. on our behalf as per
standing order. The bank debits our accounts and sends intimation to us. On receipt of intimation for the bank, we record it in our
cash book. For this, there will be a disagreement between cash book and pass book.

The Bank Charges:

Our account is debited with bank charges and interest on overdraft and intimation is sent to us by the bank. On receiving the
intimation from the bank, we record them in the cash book. For this the cash book will show more balance and the pass book will
show less balance.

Errors and Omissions:

In business, errors and omissions are very common. Someone may forget to record something or record it but in a wrong way. The
cash book balance and the pass book balance can also disagree if there is an error or mistake in the cash book or in the pass book.

DEPRECIATION

Definition and Explanation:

Depreciation is that part of the original cost of a fixed asset that is consumed during period of use by the business. The annual
charge to profit and loss account/income statement for depreciation is based upon an estimate of how much of the overall economic
usefulness of a fixed asset has been used up in that accounting period. It is an expense for services consumed in the same way as
expenses are incurred for items such as wages, rent or electricity. Because it is charged as an expenses to the profit and loss
account/income statement, depreciation reduces net profit.

For example, if a PC cost $600 and was expected to be used for three years, it might be estimated at the end of the first year that a
third of its overall usefulness had been consumed. Depreciation would then be charged at an amount equal to one third of the cost of
the PC, i.e. $200. Profit would be reduced by $200 and the value of the PC in the balance sheet would be reduced from $600 to
$400.

Using an example of a van and the petrol it consumes, you can see that the only real difference between the expense of depreciation
for the van and the expense of petrol incurred in order to use the van, is that the petrol expense is used up in a day or two, whereas
the expense for use of the van is spread over several years. Both are expenses of the business.
Causes of Depreciation:

The causes of depreciation can be divided up between physical deterioration, economic factors, the time factor, and depletion.
These are briefly explained below:

Physical Deterioration:

Wear and Tear:

When a motor vehicle or machinery or fixtures and fittings are used they eventually wear out. Some last many years, others last only
a few year. This is also true of buildings, although some may last for a long time.

Erosion, Rust, Rot and Decay:

Land may be eroded or wasted away by the action of wind, rain, sun and other elements of nature. Similarly, the metals in motor
vehicles or machinery will rust away. Wood will not eventually. Decay is a process which will also be present due to the elements
of nature and the lack of proper attention.

Economic Factors:

These may be said to be the reasons for an asset being put out of use even though it is in good physical condition. The two main
factors are usually obsolescence and inadequacy.

Obsolescence:
This is the process of becoming out of date. For example, over the years there have been great progress in the development of
synthesizers and electronic devices used by leading commercial musicians. The old equipment will therefore have become obsolete,
and much of it will have been taken out of use by such musicians.

This does not mean that the equipment is worn out. Other people may buy the old equipment and use it, possibly because they
cannot afford to buy new up-to-date equipment.

Inadequacy:
This arises when an asset is no longer used because of the growth and changes in the size of the business. For example, a small
ferryboat that is operated by a business at a coastal resort will become entirely inadequate when the resort becomes more popular.
Then it will be found that it would be more efficient and economical to operate a large ferryboat, and so the smaller boat will be put
out of use by the business. In this case also it does not mean that the ferryboat is no longer in good working order, nor that it is
obsolete. It may be sold to a business at a smaller resort.

The Time Factor:

obviously time is needed for wear and tear, erosion, etc., and for obsolescence and inadequacy to take place. However, there are
fixed assets to which the time factor is connected a different way. These assents which have a legal life fixed in terms of years. For
instance, you may agree to rent some buildings for ten years. This is normally called a lease. When the years have passed, the lease
is worth nothing to you, us it has finished. Whatever you paid for the lease is now of no value.

A similar assert is where you buy a patent so that only you are able to produce something when the patent's time has finished it then
has no value.

Instead of using the term depreciation, the term amortization is often used for these assents.

Depletion:

Other assets are of wasting character, perhaps due to the extraction of the raw materials from them. These materials are then either
used by the business to make something else, or are sold in their raw state to other businesses. Natural resources such as mines,
quarries and oil wells come under this heading. To provide for the this consumption for an asset of a wasting character is
called provision for depletion.
Definition and Explanation:

The activity method of depreciation (also called the variable charge approach) assumes that depreciation is a function of use or
productivity instead of the passage of time. The life of the asset is considered in terms of either the output it provides (units of
produces), or an input measure such as the number of hours it works. Conceptually, the proper cost association is established in
terms of output instead of hours used, but often the output is not easily measurable. In such cases, an output measure such as
machine hours is a more appropriate method of measuring the dollar amount of depreciation charges for a given accounting period.

Formula:

The following formula is used for the calculation of depreciation charge under activity method:
(Cost less salvage value) × Hours this year
= Depreciation charge
Total estimated hours

Example:

Assume that a company purchased a crane for digging purposes. Pertinently data concerning the purchase of the crane are:
Cost of crane $500,000
Estimated useful life 5 years
Estimated salvage value $50,000
Productive life in hours 30,000 hours

If the crane is used 4,000 hours the first year, the depreciation charge is:
(Cost less salvage value) × Hours this year
= Depreciation charge
Total estimated hours

($500,000 - $50,000) × 4,000

= $60,000
30,000

Where losses of services is a result of activity or productivity, the activity method will best match costs with revenues. Companies
that desire low depreciation during periods of low productivity and high depreciation during high productivity either adopt or switch
to an activity method of depreciation. In this way plant running at 40 percent of capacity generates 60 percent lower depreciation
charges.

Limitations of Activity Method of Depreciation:

The major limitation of activity method is that it is not appropriate in situations in which depreciation is a function of time instead of
activity. For example, a building is subject to a great deal of steady deterioration from the elements (time) regardless of its use. In
addition, where an asset is subject to economic or functional factors, independent of its use, the activity method loses much of its
significance. For example, if a company is expanding rapidly, a particular building may soon become obsolete for its intended
purposes. In both cases activity is irrelevant. Another problem in using this method is that an estimate of units of output or service
hours received is often difficult to determine.

Straight Line Method of Depreciation:

Definition and Explanation:

Straight line method is also known as fixed installment method and original cost method. This method is very simple and
conceptually appropriate to employ. This is one of the most widely used method for the calculation of depreciation charge. By this
method, the number of years of use is estimated and the the cost is then divided by the number of years to give the depreciation
charge each year.

Under this method , the amount of depreciation will be equal each year, since depreciation is charged at fixed rate on cost of asset.
This is the special feature of this method. If the annual depreciation is plotted on a graph paper, it will show a straight line, since the
amount of depreciation is equal every year. This is why this method is called straight line method.

Formula:

Depreciation charge under this method is calculated by using the following formula:
Cost less salvage value
= Depreciation charge
Estimated service life

Example:

Assume a machine was bought for $500,000 and we thought we would keep it for four years and then sell it for $50,000 (salvage
value) the depreciation to be charged each year would be calculated as follows:
Cost less salvage value
= Depreciation charge
Estimated service life

500,000 - $50,000*
= $90,000
5
*Salvage value

Merits:

1. Straight line method or fixed installment method is very easy to employ because of its simplicity.
2. The asset can be written off to zero value under this method.
3. This method is useful for providing depreciation on leasehold property, patent right, trade mark, copyright etc.

Demerits:

There are two major objections to the straight line method. These are:

1. This method assumes the same economic usefulness of the asset each year.
2. The repair and maintenance expenses are essentially same each period.

Another problem in the use of straight line method or fixed installment method of depreciation is that its use results in distortion in
the rate of return analysis (income/assets). The following example shows how the rate of return increases, given constant revenue
flows, because the asset's book value decreases.
Income after depreciation Rate of return
Year Depreciation Book value
expenses (income/assets)
0 $500,000
1 $90,000 $410,000 $100,000 24.4%
 2 $90,000 $320,000 $100,000 31.2%
3 $90,000 $230,000 $100,000 43.5%
4 $90,000 $140,000 $100,000 71.4%
5 $90,000 $50,000 $100,000 200.0%

Reducing Balance Method of Depreciation:

Definition and Explanation:

Under reducing balance method, the depreciation is charged at a fixed rate like straight line method (also known as fixed
installment method). But the rate percent is not calculated on cost of asset as is done under fixed installment method - it is calculated
on the book value of asset. The book value of an asset is obtained by deducting depreciation from its cost. The book value of asset
gradually reduces on account of charging depreciation. Since the depreciation rate per cent is applied on reducing balance of asset,
this method is called reducing balance method or diminishing balance method. The calculation of depreciation under this method
will be clear from the following example.

Example:

Suppose the cost of asset is $1,000 and rate of depreciation 10% p.a.
Cost of asset 1,000
Depreciation:
1st year: 10% of 1,000 100

Book value 900

2nd year: 10% of 900 90

Book value 810

3rd year: 10% of 810 81

Book value 729

and so on.......

Under fixed installment method the amount of annual depreciation remains the same but under reducing balance method the amount
of annual depreciation gradually reduces.

This method is especially suitable to assets with long life, e.g., plant and machinery, furniture, motor car etc.

Under this method the real cost of using an asset is the depreciation and repair expenses so this method gives better results because
in early years when repair expenses are less the depreciation is more. As the asset gets older repair charges on it increases and the
amount of depreciation decreases. So the combined effect of both these costs remain almost constant on the profit and loss of each
year.

The great weakness of this method is that it takes very long time to write off an asset to approximately nil, unless a very high rate is
used, in which case the burden on earlier years shall be excessive. This method is used by income tax authorities for granting
depreciation allowance to assesses.

Formula for the Calculation of Depreciation Rate:

The calculation of correct rate of depreciation is very important under this method. Following formula should be applied under
given conditions:

When the cost of asset, residual value and useful life of an asset is given:
r = 1 - (S/C)1/n

Where:

r = Rate of depreciation

n = Estimated useful life of asset

S = Residual value after the expiry of useful life

C = Original cost of asset

Example 2:

If n = 3 years, S = 64,000 and C = 1,000,000 calculate rate of depreciation.

r = 1 - (64,000/1,000,000)1/3

= 1 - 40/100

= 60/100

= 60%

Difference Between Straight Line Method and Reducing Balance Method:

Following are the main points of difference between straight line method and reducing balance method of depreciation:
Straight Line Method Reducing Balance Method

1. The rate and amount of depreciation remain 1. The rate remains the same, but the amount of depreciation
the same each year. diminishes gradually.

2. Depreciation rate per cent is calculated on cost 2. Depreciation rate per cent is calculated on book value of asset.
of assets each year

3. At the end of its life the value of asset is 3. The value of asset is never reduced to zero at the end of its life.
reduced to zero or scrap value.

4. The older the asset the larger the cost of its
repair. But the amount of depreciation remain
the same each year. Hence, the total of
depreciation and repairs increases every year.
This reduces annual profit gradually.
4. The amount of depreciation decreases gradually, while the cost of
repairs increases. So the total of depreciation and repairs remain
more or less the same each year. Hence, it causes little or no
change in annual profit/loss.

5. Computation of depreciation under straight 5. Depreciation can be computed without any difficulty, but it is not
line method is comparatively easy and simple. easy and simple.
Depreciation refers to two very different but related concepts:

1. the decrease in value of assets (fair value depreciation), and

2. the allocation of the cost of assets to periods in which the assets are used (depreciation with the matching
principle).

The former affects values of businesses and entities. The latter affects net income. Generally the cost is
allocated, as depreciation expense, among the periods in which the asset is expected to be used. Such expense
is recognized by businesses for financial reporting and tax purposes. Methods of computing depreciation may
vary by asset for the same business. Methods and lives may be specified in accounting and/or tax rules in a
country. Several standard methods of computing depreciation expense may be used, including fixed
percentage, straight line, and declining balance methods. Depreciation expense generally begins when the
asset is placed in service. Example: a depreciation expense of 100 per year for 5 years may be recognized for
an asset costing 500.

Methods of depreciation

There are several methods for calculating depreciation, generally based on either the passage of time or the
level of activity (or use) of the asset.

Straight-line depreciation

Straight-line depreciation is the simplest and most-often-used technique, in which the company estimates the
salvage value of the asset at the end of the period during which it will be used to generate revenues (useful
life) and will expense a portion of original cost in equal increments over that period. The salvage value is an
estimate of the value of the asset at the time it will be sold or disposed of; it may be zero or even negative.
Salvage value is also known as scrap value or residual value.

Straight-line method:

For example, a vehicle that depreciates over 5 years, is purchased at a cost of US$17,000, and will have a
salvage value of US$2000, will depreciate at US$3,000 per year: ($17,000 − $2,000)/ 5 years = $3,000 annual
straight-line depreciation expense. In other words, it is the depreciable cost of the asset divided by the
number of years of its useful life.

This table illustrates the straight-line method of depreciation. Book value at the beginning of the first year of
depreciation is the original cost of the asset. At any time book value equals original cost minus accumulated
depreciation.

book value = original cost − accumulated depreciation Book value at the end of year becomes book value
at the beginning of next year. The asset is depreciated until the book value equals scrap value.
Book value at Depreciation Accumulated Book value at
beginning of year expense depreciation end of year
$17,000 (original cost) $3,000 $3,000 $14,000
$14,000 $3,000 $6,000 $11,000
$11,000 $3,000 $9,000 $8,000
$8,000 $3,000 $12,000 $5,000
$5,000 $3,000 $15,000 $2,000 (scrap value)

If the vehicle were to be sold and the sales price exceeded the depreciated value (net book value) then the
excess would be considered a gain and subject to depreciation recapture. In addition, this gain above the
depreciated value would be recognized as ordinary income by the tax office. If the sales price is ever less than
the book value, the resulting capital loss is tax deductible. If the sale price were ever more than the original
book value, then the gain above the original book value is recognized as a capital gain.

If a company chooses to depreciate an asset at a different rate from that used by the tax office then this
generates a timing difference in the income statement due to the difference (at a point in time) between the
taxation department's and company's view of the profit.

Declining-balance method (or Reducing balance method)

Depreciation methods that provide for a higher depreciation charge in the first year of an asset's life and
gradually decreasing charges in subsequent years are called accelerated depreciation methods. This may be
a more realistic reflection of an asset's actual expected benefit from the use of the asset: many assets are most
useful when they are new. One popular accelerated method is the declining-balance method. Under this
method the book value is multiplied by a fixed rate.

Annual Depreciation = Depreciation Rate * Book Value at Beginning of Year

The most common rate used is double the straight-line rate. For this reason, this technique is referred to as the
double-declining-balance method. To illustrate, suppose a business has an asset with $1,000 original cost,
$100 salvage value, and 5 years useful life. First, calculate straight-line depreciation rate. Since the asset has
5 years useful life, the straight-line depreciation rate equals (100% / 5) 20% per year. With double-declining-
balance method, as the name suggests, double that rate, or 40% depreciation rate is used. The table below
illustrates the double-declining-balance method of depreciation.
Book value at Depreciation Depreciation Accumulated Book value at
beginning of year rate expense depreciation end of year
$1,000 (original cost) 40% $400 $400 $600
$600 40% $240 $640 $360
$360 40% $144 $784 $216
$216 40% $86.40 $870.40 $129.60
$129.60 $129.60 - $100 $29.60 $900 $100 (scrap value)

When using the double-declining-balance method, the salvage value is not considered in determining the
annual depreciation, but the book value of the asset being depreciated is never brought below its salvage
value, regardless of the method used. The process continues until the salvage value or the end of the asset's
useful life, is reached. In the last year of depreciation a subtraction might be needed in order to prevent book
value from falling below estimated Scrap Value.

Since double-declining-balance depreciation does not always depreciate an asset fully by its end of life, some
methods also compute a straight-line depreciation each year, and apply the greater of the two. This has the
effect of converting from declining-balance depreciation to straight-line depreciation at a midpoint in the
asset's life.

It is possible to find a rate that would allow for full depreciation by its end of life with the formula:
 ,

where N is the estimated life of the asset (for example, in years).

*****REFER PRACTICAL QUESTIONS FROM BOOK PROVIDED.