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Advantages & Disadvantages of the Reducing Balance Method
The reducing balance method has its fair share of advantages and disadvantages that shouldn't be ignored. Get tips on the advantages and disadvantages of the reducing balance method with help from a senior financial analyst in this free video clip.
Hi, I'm Jackie Jackson, and I'm gonna talk to you about the advantages and disadvantages of the reducing balance method. Now, the reducing balance method of depreciation is a method in which the asset is depreciated by a set percentage, as opposed to value, every month. For example, in the straight line method of depreciation, you determine the useful life of the asset, for example five years, and if the asset is worth a hundred dollars, then you divide a hundred by five, you get a twenty dollar depreciation each year. In the reducing balance method, you again, apply a specific percentage, so let's say you're gonna use 20 percent with that same hundred dollar asset. In the first year you're gonna reduce it by 20 dollars. In the second year the asset now has a value of 80 dollars, so you're gonna reduce it by 20 percent of that, which is 16 dollars, and so on until you reach the end of the useful life of the asset, and you have the salvage value. Now the advantage of this system is that it's relatively simple compared to some more complex systems of depreciation, and also it enables you to match the revenues generated by the asset to the depreciation period. However, there is the disadvantage of having to come up with a salvage value for the asset, and also you are required to take depreciation in the first year and that asset might not necessarily be generating revenues for you in that first year.