Every entrepreneur who has assets to depreciate in their balance sheet should know the difference between straight-line and declining balance depreciation. Even if the names may first sound scary, it is worth giving them a chance! In the end, depreciation is only mathematics and learning it does not take a whole day. Relax your shoulders and clear your mind – here we go!

Planned depreciation

Tax instructions explain that planned depreciation means recording the cost of fixed assets as expenses systematically during their useful life. A complicated sentence, but what does it really mean?

Planned depreciation is only the plan you follow when you make depreciation. There are not three options called straight-line, declining balance and planned depreciation. There are only straight-line and declining balance depreciation. When you choose one of them, that is your planned depreciation method.

So, when you buy assets for your company, you need to check whether you use straight-line or declining balance depreciation. Once you know this, you already have a plan and you can start making planned depreciation. Easy as that!

Straight-line depreciation

Let’s start with the easier, but less used method among small businesses – straight-line depreciation. As the name says, it means that the depreciation is made evenly every year.

Straight-line depreciation is a method where the cost of an asset is reduced with a fixed sum during a certain time. To use it, you need to know the acquisition price of the asset and its useful life. Every year you make the same depreciation until the value in the balance sheet is zero and there is nothing left to depreciate. Straight-line depreciation is chosen when the effect of the asset on the company is the same every year of its useful life. Very simple!

Examples of assets that can be depreciated with the straight-line method are renovation costs of a rented property, connection fees, trademark rights, computer programs, patents and copyrights. Machines, equipment and similar assets are not depreciated this way – for them, the declining balance method is used.

Straight-line depreciation is quite easy to understand, but here is one example just in case:

A fish seller renovates a rented shop during the year with 50,000 euros. The renovation brings benefit every year equally, so straight-line depreciation is used.

The shop is rented for five years, so the seller benefits from the renovation for the next five years.

The calculation formula is simple: acquisition price divided by useful life. In this case: 50,000 € / 5 years = 10,000 € per year.

So, the fish seller reduces his result with 10,000 € every year for five years. After five years, the balance sheet shows zero and the straight-line depreciation ends.

Declining balance depreciation

Even if the word “declining balance” may sound difficult, keep reading! By the end of this section, it will feel much clearer.

Examples of assets depreciated with the declining balance method are production machines and equipment, vehicles, tools and office furniture. This method is very common among small companies.

Declining balance depreciation is used when the asset has more effect on income in the beginning than later. In other words, you earn more with the asset right after buying it, and the effect gets smaller over time. In this method, you reduce every year a fixed percentage of the remaining value (the undepreciated cost). It sounds more difficult than it really is! Let’s check an example:

A taxi driver buys a car for his business. The price without VAT is 25,000 euros. The taxi driver can immediately start transporting customers, so the car is more important in the first years than later. At the end of the year, the taxi driver wants to make the maximum depreciation, which is 25% (for 2021–2023, the maximum for machinery and equipment was 50%).

The formula: 25,000 € × 25% = 6,250 €.

The result of the year is reduced by 6,250 €, and in the balance sheet the remaining value is 25,000 € – 6,250 € = 18,750 €.

This remaining value is called “residual value” (the part not yet deducted in taxation).

Next year, the depreciation is calculated from the residual value, not from the original price. So: 18,750 € × 25% = 4,687.50 €. This reduces the result by 4,687.50 € and leaves in the balance sheet 18,750 € – 4,687.50 € = 14,062.50 €. The next year, the same is repeated from this new residual value, and so on. Pure mathematics!

If the taxi driver later buys another car, it is added to the same pool as the first one. So now the company’s balance sheet shows residual value of the old car 14,062.50 € plus the acquisition cost of the new car 25,000 €, total 39,062.50 €. Depreciation is calculated from this sum: 39,062.50 € × 25% = 9,765.63 €. After depreciation, residual value left is 39,062.50 € – 9,765.63 € = 29,296.87 €.

Residual value never goes completely to zero with depreciation. The maximum you can deduct is always 25% of what is left. But, if you can show that the asset has no value anymore, or that its value is lower than the amount in the balance sheet, you can make an additional depreciation. With this extra depreciation, you can adjust the value to the real value, or even write off the whole residual value if the asset is worthless.

Conclusion

Even if their names sound difficult, both straight-line and declining balance depreciation are actually simple. And don’t worry – you don’t need to memorize them all at once. When you actually start doing them, everything will fall into place naturally!