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FSA - Double-Declining Depcreciation

Hello,

CFA Vol 3, Reading 25, Problem 16

Straight-Line Depreciation = (Asset Cost-Salvage Value)/ Expected Life of Asset

The solution to problem 16 states: ‘residual value is not subtracted from the initial book value to calculate depcreciation. However, the book value (carrying amount) of the asset will not be reduced below the estimated residual value.

My question is why isn’t residual value subtracted for double-depreciation as it is for single-line depr? I’m not asking for anything super in-depth, just something that makes a little sense.

Thanks in advance,

Justin

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Not sure why residual value is not included in the formula (but my guess is that it over exaggerrates the initial depreciation cost by a lot). However, you do need  to remember that depreciation ends once the residual value has been reached under DDB method. 

If an asset has 0 risdual value at the end of its life, then the asset will never depreciate fully under the DDB method (that’s where some companies make the decision to switch to straight line method instead).

Hope this helps!

Thanks!

The key is the depreciation rate. The depreciation rate is based on the asset’s depreciable value. For instance, if Asset= 1000, salvage value = 200 and useful life is 5 years, then straight line dep. = 1000-200/5= 160. The depreciation rate will be equal to 160/800 = 20%. 800 is the depreciable value of the asset. So to find the DDB you simply multiply the straight line rate by 2, which gives you 40%. Depreciation is based on the depreciable value of the assets, not the book value.To answer your question, residual value is substracted from the book value of the asset for DDB. I am not sure about the solution though, maybe is there another way to interpret depreciation ?

The easy way I think about it is that in a DDB, your asset will never reach a book value of 0, no matter for how long you depreciate it. Thus, you would never fully depreciate the asset if you subtracted the book value in advance.

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majda.sd wrote:

Not sure why residual value is not included in the formula (but my guess is that it over exaggerrates the initial depreciation cost by a lot). However, you do need  to remember that depreciation ends once the residual value has been reached under DDB method. 

If an asset has 0 risdual value at the end of its life, then the asset will never depreciate fully under the DDB method (that’s where some companies make the decision to switch to straight line method instead).

Hope this helps!

You have explained it so beautifully! yes

Best regards,

Sooraj.