Depreciation on Balance Amount Method

Depreciation is a reduction in the value of an asset over time due to wear and tear, obsolescence, or any other reason. It is an important concept in accounting as it is used to allocate the cost of an asset over its useful life. There are various methods of calculating depreciation, one of which is the depreciation on balance amount method.

Definition

The depreciation on balance amount method is a depreciation method under which depreciation is calculated on the balance amount of an asset after deducting the depreciation charged in the previous years. In other words, the book value of the asset is reduced by the depreciation charged in the previous years, and the remaining balance is used to calculate the depreciation for the current year.

Calculation of Depreciation

The calculation of depreciation under this method can be explained with the help of an example. Let us assume that the cost of a machine is $10,000, and it has a useful life of 5 years. The salvage value of the machine is assumed to be zero. The depreciation rate is calculated as follows:

Depreciation Rate = (Cost of Asset - Salvage Value) / Useful Life
= ($10,000 - $0) / 5
= $2,000 per year

Now, let us assume that the machine has been in use for 3 years. The accumulated depreciation for the first two years is $4,000 (i.e., 2 x $2,000). The book value of the machine at the beginning of the third year is $6,000 (i.e., $10,000 - $4,000). The depreciation for the third year will be calculated as follows:

Depreciation for the Third Year = (Book Value at the Beginning of the Year - Accumulated Depreciation)
= ($6,000 - $4,000)
= $2,000

Advantages and Disadvantages

Advantages:
- This method provides a more accurate picture of the asset's value as it takes into account the depreciation charged in the previous years.
- It results in a lower amount of depreciation expense in the later years of an asset's life.

Disadvantages:
- This method is more complicated to calculate than some other methods.
- It does not take into account the time value of money, which can result in an overstatement of the asset's value in the later years.

Conclusion

The depreciation on balance amount method is a useful method for calculating depreciation as it takes into account the depreciation charged in the previous years. However, it is more complicated to calculate than some other methods, and it does not take into account the time value of money. As such, it is important to carefully consider the advantages and disadvantages of this method before deciding whether to use it.