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Reducing balance

A means of recording depreciation expenses in which the original cost of an asset is ‘written down’ by a fixed fraction each year. In this way, the amount of depreciation allowed falls each year: a machine casting £500 could be written down by 20 per cent per annum, i.e. £1OO in the first year and then 20 per cent on its written down value of £400, i.e. £80, in the following year, and so on. A rate can be chosen to write down an asset to an expected residual value in a chosen period of years, e.g. five years and £50, which in our example would require an annua] depreciation rate of about 53 per cent. Although the reducing-balance system gives a lighter depreciation charge in later years when maintenance and repair costs as well as risk of obsolence may be higher (as opposed to the straight-line method, where equal depreciation is charged every year), it is unlikely to accord very closely with actual depreciation. However, the taxation authorities in Britain and other countries base tax allowances for certain capital investment on a reducing balance.

Reference: The Penguin Dictionary of Economics, 3rd edt.