Residue method: types, application, calculation formula

When calculating depreciation amounts, companies can apply various existing methods, which are the most optimal for the features of their functioning. One such option is a reduced residue method. This method should be specified in the accounting policies of the company.

Various depreciation methods are based on the formula. This formula is obtained on the basis of a study of the behavior of assets over a specified period of time.

In depreciation in a straight line (linear depreciation), an entity includes an equal amount of depreciation expense for each year the asset is used. The residual method, also known as the diminishing asset method or the accelerated method, transfers a large amount of depreciation in the first years of the asset's life. This concept works well if the business wants to receive a substantial tax deduction, but at the same time reduces tax incentives for depreciation in subsequent years. Let's learn more about this method as part of this article.

Concept

In accordance with the balance method, depreciation is charged at a fixed percentage of the carrying amount of the asset. As the book value decreases every year, therefore, the depreciation amount also decreases every year. With this method, the value of an asset never decreases to zero.

When the amount of depreciation accrued by this method and the corresponding period are plotted on the chart, a line is moving down.

This method is based on the assumption that in earlier years the cost of repair and restoration of assets was low, and therefore a large amount of depreciation should be charged. In addition, in subsequent years, the cost of repairs increases, and therefore, the depreciation amount will be reduced. This means that this method leads to the same burden on profits every year.

However, in accordance with this method, if the applicable depreciation rate is not suitable, it may happen that at the end of the asset's life, full depreciation will not be provided. Also, when applying this method, the period of use of the asset should be taken into account. If the asset is used only for 2 months in a year, depreciation will be charged only for 2 months.

Method scope

The balance method is used as an option that allows you to measure the value of the property in a situation where the objects are characterized by uneven returns during the period of application. Moreover, the potential of the object is used precisely in the first years of its application. An example of such objects is digital technology, which is characterized by very rapid obsolescence.

The possibilities of applying this technique are specified in RAS 6/01 “Accounting for fixed assets”. This depreciation option differs significantly in its concept from the linear method.

Thus, the situations of applying this method are as follows:

• unique equipment;
• cars;
• office furniture;
• equipment for up to three years.

What is a decrease in depreciation of an asset?

Reducing the depreciation of an asset is a method of calculating depreciation in which the asset is consumed with a specified percentage.

Depreciation using the reduced balance method reduces the amount of depreciation in the form of expenses with each subsequent year. In other words, more depreciation is accrued at the beginning of the asset's life, and less is towards the end.

This can be useful when an asset has a higher utility or productivity at the beginning of its life. For example, many types of machines have higher functionality when they are new, and therefore bring more revenue compared to the last years of their lives. Reducing the depreciation of an asset ensures that depreciation expense reflects the performance, functionality and ability of the assets to generate income.

Formula for calculating depreciation rate

The calculation of the correct depreciation rate is very important with this method. The following formula for the remainder method:

r = 1 - (S / C) ^{1 / n} ,

Where:

• r is the depreciation rate;
• n is the term of use of the object;
• S - the value of the object according to the balance after the period of use;
• C is the initial value of the object.

Calculation example:

If n = 3 years, S = 64,000 and C = 1,000,000, then we calculate the depreciation rate.

r = 1 - (64,000/1,000,000) ^1/3

= 1 - 40/100 = 60/100 = 60%

What do you need to know for calculations?

To calculate the depreciation of an asset, you need to know:

1. Asset value: the initial cost of the asset plus any additional costs necessary to prepare the asset for its intended use.
2. Residual value: also known as residual value. This is the value of the asset after the expiration date.
3. Depreciation rate: it corresponds to the percentage with which the asset will be depreciated every year. For example, 2 is 200%, 0.5 is 50%.

Settlement Stages

Using the available information, the balance method allows you to calculate depreciation in two stages:

Step 1. We calculate depreciation deductions according to the following formula:

Depreciation charge per year = (net book value - residual value) * depreciation indicator

Step 2. We calculate depreciation from the current book value to calculate the remaining book value.

These steps should be repeated every time as the object is applied. In the last year, the residual value should be deducted from the current carrying amount and the amount recorded as an expense.

Keep in mind that this is only one way to calculate residual value.

Why are there different depreciation methods?

For direct depreciation, an entity recognizes an equal amount of depreciation expense for each year an asset is used. Depreciation using the reduced balance method transfers large depreciation in the first years of an asset’s life. This works well if a business wants a larger immediate tax deduction, but reduces tax depreciation incentives in subsequent years.

Calculation of Amounts

When using the reduced balance method, accruals on an asset are depreciated at a higher interest rate than depreciation on a straight line basis. To calculate depreciation using the reduced balance method, follow these steps:

1. Calculate the depreciation percentage in a straight line based on the application period and multiply it by two. For example, if the term is 10 years, it will be amortized at the level of 10 percent per year on a straight line and 20 percent per year with a reduced balance.
2. Multiply the carrying amount of the asset by a double decreasing percentage to find the depreciation expense. For example, if an asset is worth 5,000,000 rubles, then using the reduced balance method, depreciation will amount to 20 percent of 5,000,000 rubles or 1,000,000 rubles.
3. Calculate accumulated depreciation from the cost of the asset to find the current carrying amount. In this example, the new current carrying amount is 5,000,000 rubles, less 1,000,000 rubles or 4,000,000 rubles.
4. Next year, multiply the new book value by the double decreasing asset rate to find depreciation for that year. In our example, this will be 20 percent of 4,000,000 rubles or 800,000 rubles.
5. Repeat the operation until the asset is fully depreciated.

An example of the method of residues No. 1

The company buys a van for 5,000,000 rubles. According to company estimates, the van will lose 40% of its value each year, and the cost of depreciation will be 1,000,000 rubles. Following the reduced balance method, the first five years, the depreciation calculation will look like this:

Second example

Assume that the value of the asset is 1,000,000 rubles, and the depreciation rate is 10% per annum.

With the fixed method, the amount of depreciation remains constant, but with the method of decreasing the balance of accruing the amount of annual depreciation, it gradually decreases. It is a fact!

When analyzing residuals, the reduction method is suitable for assets with a long service life, such as machinery and equipment, furniture, automobiles, etc.

According to this method, the real cost of using an asset is the cost of depreciation and repair. It gives better results because in the early years, when repair costs are lower, depreciation is greater. As an asset ages, the cost of repairs increases, and the amount of depreciation decreases. Thus, the combined effect of the two types of costs remains almost constant value in the amount of profit of each year.

The disadvantage of this method is that asset cancellation takes a long time to zero unless a very high rate is used, in which case the burden on earlier years will be excessive.

Comparison with linear depreciation

An alternative method is linear depreciation. Whereas in the case of the reduced balance method, depreciation is charged as a percentage of the carrying amount of the asset, the linear method uses the same amount annually.

Linear wear cannot account for a higher level of performance and functionality at the beginning of the facility’s life. However, for most small businesses enough. They are much more comfortable using the linear method.

The difference between the methods

Below are the main differences between the direct method and the method of calculating depreciation from the remainder.

We compare two methods using specific calculation examples.

An example of a linear method:

Equipment in the form of a machine has a cost of 423,000 rubles. The term of use is 8 years.

Amount of depreciation per year: 423,000: 8 = 52 8775 rub.

Another option: calculate the annual depreciation percentage: 100/8 = 12.5%

Amortization amount: 423,000 * 12.5% ​​= 52,875 rubles.

An example of a reduced remainder method:

Initial data: annual depreciation rate of 12.5%.

The depreciation amount in 1 year is the same: 52,875 rubles.

This amount is deducted from the cost of the machine in 2 years: 423 000 - 52 875 = 370 125 rubles.

Depreciation in the second year: 370,125 * 12.5% ​​= 46,266 rubles.

Monthly depreciation amount: 46266/12 = 3855 rubles.

Residual value of the second year:

370 125 - 46 266 = 323 859 rub.

Further, the calculations follow the same pattern for 8 years.

Acceleration coefficient

However, the above examples do not take into account the fact that the main tool can be used very intensively, that is, wear out much faster. In such a situation, we add another variable value to the calculation formula - the depreciation acceleration coefficient. It can be no higher than 3 (Clause 19 PB 6/01). It can be used exclusively in the case of a reduced residue technique. In other options for depreciation, it is considered unjustified.

In general, the value of this indicator is set by the company independently and is stipulated in its accounting policy. But its value must have a convincing justification. As such, the technical documentation of the facility, permits of the authorities, schedules for going to work, timesheets, acceptance certificates, etc. can be used.

The formula of the remainder method using this indicator looks like this:

GN = 1 * 100 * Ku / SPI,

Depreciation annual = OS * GN,

Depreciation every month = Depreciation annual / 12,

OS = P - ON,

Where:

• Ku is an accelerating coefficient that the company sets for itself. The value ranges from 1 to 3;
• SPI - the useful life of the OS object;
• PS - initial cost - this is the value at which the object is taken into account in the company;
• ON - accumulated depreciation, this is the amount of deductions for the facility over its entire service life;
• OS - residual value, this is the difference between the initial cost and the amount of depreciation;
• GN - annual depreciation rate - the value in%, reflecting the share of the value of the object, which is expensed every year.

The method of the dry residue in depreciation

This concept is applied in case of early retirement of funds, that is, in a situation where a company has to “part” with fixed assets before the expiration of their term of use. At the same time, the amount of under-accrued depreciation remains upon liquidation.

Application of methodology to property

The balance method in the valuation of property can be used in relation to land. It is carried out taking into account the factors of profit formation. Initially, this method was developed for agricultural land. In this situation, income is considered as residual. The methodology evaluates a plot of land with improvements in relation to its commercial use. An analysis is made of the most effective option for its application with a focus on generating income.

Reduced Balance Benefits

The main advantage of the method is the tax benefit. According to the reduced balance, an entity may apply larger amounts of deduction for depreciation tax in the early stages. Most businesses are likely to receive tax credits sooner rather than later. From the point of view of financial accounting, the reduced balance method makes sense for assets that are rapidly losing value, such as new cars and other vehicles. For these assets, a decrease in depreciation on the balance sheet better matches depreciation expenses with an actual decrease in fair market value.

The application of the method is justified when the OS object must be written off quickly. For example, a computer. Since more progressive models appear every year, even when the deadline for this facility has not come to an end, the computer may no longer cope with the tasks.

The disadvantages of the method

There are some tax scenarios in which a company may not want to apply larger tax benefits at an early stage. For example, if a company already has tax losses for the year, it will not receive an additional tax deduction. An even distribution of deductions can help enterprises avoid higher tax payments in subsequent years. For assets that do not lose their value quickly, such as equipment and machinery, an accelerated depreciation method makes no logical sense. You can more accurately depreciate these assets based on how much they are being used.

Conclusion

The reduced balance method is especially relevant for OS objects that wear out very quickly (including morally). The cost of such an object is written off by monthly depreciation, starting from the month following the time of acquisition of this object. The balance method is a type of valuation of fixed assets. This is clear.

When determining by the method of residuals, they are based on the use of residual value and accelerating coefficient.

Calculation by this method is carried out on the value of the residual value, which allows you to have maximum deductions in the first months and years of application of the object. And then over time, these amounts are reduced. With the introduction of an additional accelerating factor, the write-off process becomes even faster. But the use of such an indicator must be justified.