How does the double-declining balance method minimise tax payments?
Double-declining balance method (" DDM") of depreciation allocate more depreciation charges during the earlier life of the asset. At such, depreciation expenses will be higher (relative to another firm which uses straight line depreciation).
Higher depreciation expenses reduce the amount of pre-tax income which give rise to lower tax payment.
Going forward, tax expenses will increase under DDM as the amount of depreciation expenses decrease throughout the useful life of the asset’s life. This is in contrary to straight line depreciation for which the depreciation expenses are constant.
So if you are going to place the 2 firms side by side to compare this is what you will get:
Year Depreciation expenses(DDB) Depreciation expenses(SL)
_ 1 Higher Lower _
_ Subsequent years Lower Higher _
Thanks Ernest, that really makes sense. Didn’t think about the fact that DDM will cause taxes to be higher in later years.
I mean it is on a relative basis; as compared to other depreciation method e.g. straight line depreciation, DDM allocate more depreciation charges during the earlier life of the asset and at such the income available to be taxed will be lower; and as the years go by depcreiation charges will be relatively lower and thereafter lower taxes.