Fundamentals of Business

Reducing Balance

Reducing Balance. Where equipment depreciates by a constant percentage over a period.

Suppose

The price of a brand new equipment is P The constant percentage depreciation per period is d

Then at the end of period 1
Depreciation will be P x d = Pd
Therefore its remaining book value will be
Brand new price - depreciation = P - Pd = P(1 - d) equation 1
This will be its book value at the beginning of period 2
Since depreciation is constant, at the end of period 2
Deprecation will be = value at the beginning of period 2 x percentage depreciation = P(1 - d) x d

Therefore its remaining value at the end of year 2 will be
value at the beginning of period 2 - depreciation at the end of period 2
P(1 - D) -[P(1 - d) x d] = P(1-d)(1 - d) = P(1 - d)2 Equation 2
We can see from equation two, the factor (1 - d) has been raised to the power of two
Therefore its value at the end of period n will be Valuen = P (1 - d)n

This is the formula for calculating depreciation based on reducing balance. Note d is expressed as a decimal = d/100

Example
Suppose a brand new refrigerator costs £300 and depreciates by 20% annually. How much will be worth after three years?

Solution
Identifying the variables
P = £300
d = 20/100 = 0.2
n = 3
At the end of year 3 it will be worth = 300(1 - 0.2) 2 = £192
Sinking funds
For simplicity we will skip this method of calculating depreciation.

Factors contibuting to depreciation

. Time
Example: wear and tear
. Technonology
Example :
Processors: Intel Celeron vs Intel Pentium I,II, III, IV, Duo core
. Substitutes