Declining balance depreciation

What it means

Declining balance depreciation is a method in which charges are highest in the first years and gradually fall, because the asset loses value fastest early on. Typical examples are cars and computer equipment, whose market price drops sharply right after purchase.

The opposite is straight-line depreciation, where the same amount is charged every year. A declining pattern can be achieved in different ways, such as charging a fixed percentage of the remaining book value or the sum-of-the-years'-digits method.

In Slovak tax law its counterpart is accelerated depreciation, which the Income Tax Act allows for selected depreciation groups. In the accounts, the company chooses its own method in the depreciation plan based on how the asset actually wears out.

How it works in practice

For tax, accelerated depreciation can be used for assets in the second and third depreciation groups, such as machinery and certain equipment. It is excluded for passenger cars in the first group, so these are depreciated on a straight-line basis for tax.

If accounting depreciation differs from tax depreciation, a difference arises between the asset's book and tax values. Companies that account for deferred tax record this temporary difference, and in the tax return the difference in depreciation is added back or deducted.

Higher depreciation at the start lowers the tax base in the early years, improving cash flow. Total depreciation over the asset's life stays the same; only the timing changes, so the declining method defers tax rather than saving it.

What to watch out for

If an asset is sold before it is fully depreciated, its remaining book value is expensed, and under the declining method this value is lower. The gain on sale is therefore higher, which must be considered when comparing profitability across years.

Changing the method part-way through is usually restricted. For tax, the depreciation method for a given asset generally cannot be changed, so it must be chosen when the asset is brought into use and justified in an internal policy.