<<–2/”>a href=”https://exam.pscnotes.com/5653-2/”>h2>WDV: Written Down Value Method of Depreciation
What is WDV Method?
The Written Down Value (WDV) method, also known as the Reducing Balance Method, is a widely used depreciation method for accounting purposes. It calculates depreciation based on a fixed Percentage of the asset’s book value (cost less accumulated depreciation) at the beginning of each accounting period. This method reflects the reality that assets tend to depreciate faster in their early years and slower as they age.
How WDV Method Works
- Determine the Depreciation Rate: The depreciation rate is a fixed percentage set by the company based on factors like the asset’s useful life and expected rate of decline in value.
- Calculate Depreciation Expense: The depreciation expense for each period is calculated by multiplying the depreciation rate with the asset’s book value at the beginning of the period.
- Update Book Value: The book value is reduced by the depreciation expense calculated in step 2. This updated book value becomes the basis for calculating depreciation in the next period.
Formula for WDV Method
Depreciation Expense = Depreciation Rate * Book Value at the Beginning of the Period
Advantages of WDV Method
- Realistic Depreciation: Reflects the declining value of assets more accurately than the straight-line method.
- Tax Benefits: Higher depreciation expense in the early years can lead to lower taxable income and tax Savings.
- Simplicity: Relatively easy to calculate and apply.
Disadvantages of WDV Method
- Arbitrary Depreciation Rate: The depreciation rate is subjective and can be influenced by factors other than the asset’s actual decline in value.
- Lower Book Value: The book value of the asset decreases rapidly in the early years, which may not reflect its actual market value.
- Limited Applicability: Not suitable for assets that have a constant rate of depreciation throughout their useful life.
Example of WDV Method
Let’s consider a machine purchased for $100,000 with a useful life of 5 years and a depreciation rate of 20%.
| Year | Beginning Book Value | Depreciation Expense | Ending Book Value |
|---|---|---|---|
| 1 | $100,000 | $20,000 (20% of $100,000) | $80,000 |
| 2 | $80,000 | $16,000 (20% of $80,000) | $64,000 |
| 3 | $64,000 | $12,800 (20% of $64,000) | $51,200 |
| 4 | $51,200 | $10,240 (20% of $51,200) | $40,960 |
| 5 | $40,960 | $8,192 (20% of $40,960) | $32,768 |
As you can see, the depreciation expense decreases each year, reflecting the declining book value of the machine.
Comparison of WDV Method with Straight-Line Method
| Feature | WDV Method | Straight-Line Method |
|---|---|---|
| Depreciation Expense | Decreases over time | Remains constant over time |
| Book Value | Decreases rapidly in early years | Decreases linearly over time |
| Suitability | Assets with declining value | Assets with constant value |
| Tax Benefits | Higher depreciation in early years | Lower depreciation in early years |
WDV Method vs. SLM: Which is Better?
The choice between WDV and SLM depends on the specific circumstances of the asset and the company’s accounting policies.
- WDV is preferred for assets that depreciate rapidly in the early years. This is because it reflects the actual decline in value more accurately and provides tax benefits in the early years.
- SLM is preferred for assets that depreciate at a constant rate. This is because it provides a more consistent depreciation expense over the asset’s useful life.
Factors Affecting Depreciation Rate
- Asset’s Useful Life: The expected period of time the asset will be used.
- Expected Rate of Decline: The estimated rate at which the asset’s value will decrease.
- Industry Practices: Common depreciation rates used in the industry.
- Company Policies: The company’s own accounting policies regarding depreciation.
Accounting Standards for WDV Method
The WDV method is recognized by various accounting standards, including:
- International Financial Reporting Standards (IFRS): Allows the use of the reducing balance method, which is similar to WDV.
- United States Generally Accepted Accounting Principles (GAAP): Allows the use of the declining balance method, which is similar to WDV.
Frequently Asked Questions (FAQs)
Q: What is the difference between WDV and SLM?
A: The WDV method calculates depreciation based on a fixed percentage of the asset’s book value, while the SLM method calculates depreciation based on a fixed amount each year.
Q: How do I choose the depreciation rate for WDV?
A: The depreciation rate is determined based on factors like the asset’s useful life, expected rate of decline, industry practices, and company policies.
Q: What are the tax implications of using WDV?
A: The WDV method can lead to higher depreciation expense in the early years, which can result in lower taxable income and tax savings.
Q: Can I switch from WDV to SLM?
A: Yes, you can switch from WDV to SLM, but you need to follow the accounting standards and company policies regarding depreciation changes.
Q: What is the residual value in WDV?
A: The residual value is the estimated value of the asset at the end of its useful life. It is not considered in the WDV calculation, as the depreciation continues until the book value reaches zero.
Q: How does WDV affect the financial statements?
A: The WDV method affects the income statement by reducing the net income through depreciation expense. It also affects the balance sheet by reducing the asset’s book value over time.
Q: What are some examples of assets that are suitable for WDV?
A: Assets that depreciate rapidly in the early years, such as computers, machinery, and vehicles, are suitable for WDV.
Q: What are some examples of assets that are not suitable for WDV?
A: Assets that depreciate at a constant rate, such as land and buildings, are not suitable for WDV.
Q: What are the limitations of WDV?
A: The WDV method can be subjective and may not accurately reflect the actual decline in value of the asset. It can also lead to a lower book value than the actual market value of the asset.
Q: What are some alternatives to WDV?
A: Alternatives to WDV include the straight-line method, the sum-of-the-years’ digits method, and the units of production method.
Q: How does WDV affect the valuation of a company?
A: The WDV method can affect the valuation of a company by influencing its profitability and asset values. Higher depreciation expense in the early years can lead to lower profits, but it can also result in a lower tax burden.
Q: What are the ethical considerations of using WDV?
A: It is important to use the WDV method ethically and transparently. The depreciation rate should be based on reasonable estimates and should not be manipulated to artificially inflate or deflate profits.