Reducing Balance Method This method assumes that more value is lost at the start of the life of an asset, than at the end We use a fixed percentage – e.g. 20% We assume that the asset loses this percentage of its start of year value in depreciation

Reducing Balance Method – An Example An asset was bought for £10,000. We will use it for 3 years. We will depreciate it 20% each year using the reducing balance method. Year 1 – Start value = £10,000 It depreciates by 20% = 20% of £10,000 = £2,000 It is now worth £8,000 Year 2 – Start Value = £8,000 = 20% of £8,000 = £1,600 It is now worth £6,400 Year 3 - Start Value = £6,400 = 20% of £6,400 = £1,280 It is now worth £5,120

Depreciation and Profit Because depreciation is looking at the loss of the value of an asset, it reduces profit We treat depreciation as an expense when calculating profit So if an asset depreciates by £1,000 – we have an extra £1000 costs that year…. ….and profit will be reduced by £1,000

Differences in Methods Depending on which method you use, you could end up with very different figures for depreciation If depreciation is high, expenses will be high, and therefore profits will be low If depreciation is low, expenses will be lower, hence profits will appear high That’s why the accountant in a business must choose an appropriate method of deprecation depending on the type of asset, how its used, what its used for, etc, etc As you could imagine, depreciation is very much guess work, and some businesses have been found out trying to mislead people by recording very high or low depreciation figures