Depreciation represents the systematic reduction in the value of an asset over its useful life due to wear and tear, usage, or obsolescence. It helps in presenting a fair and realistic value of assets in the financial statements.
There are various methods to calculate it, and the Written Down Value (WDV) Method, also known as the Diminishing Balance Method, is one of the popular methods used by accountants and businesses.
This method reflects how most assets actually lose their value—more rapidly in the beginning and gradually over time.
Meaning of the Written Down Value Method
Under the Written Down Value Method, depreciation is charged at a fixed percentage on the book value of the asset at the beginning of each year. Since the book value keeps decreasing every year after charging depreciation, the amount of depreciation also becomes smaller over time, though the rate remains the same.
For example, if a machine costs ₹100,000 and the rate of depreciation is 10% per annum, the depreciation for the first year will be ₹10,000. In the second year, the same rate is applied to the reduced book value of ₹90,000, giving ₹9,000 as depreciation. This process continues until the asset’s value reduces to its residual value.
This method is particularly suitable for assets like machinery, computers, and vehicles, which tend to lose more value in the initial years of use.
Example of the Written Down Value Method
Suppose a company purchases equipment for ₹200,000 on April 1, and the depreciation rate is 10% per annum. The depreciation calculation would be as follows:
| Year | Opening Book Value (₹) | Depreciation (10%) (₹) | Closing Book Value (₹) |
|---|---|---|---|
| 1st Year | 200,000 | 20,000 | 180,000 |
| 2nd Year | 180,000 | 18,000 | 162,000 |
| 3rd Year | 162,000 | 16,200 | 145,800 |
Advantages of the WDV Method
Reflects Real Asset Behavior: Many assets such as machinery, computers, and vehicles lose a significant portion of their value in the initial years. The WDV method captures this decline accurately, making financial statements more realistic.
Scientific and Logical Approach: The method is based on the assumption that assets contribute more in the early years and less in later years. This principle aligns with how most assets generate revenue in real operations.
Better Matching of Costs with Revenue: Since higher depreciation is charged when the asset is new and generating higher income, and lower depreciation when it is older and generating less income, the method ensures a logical match between cost and benefit.
Encourages Asset Replacement: The rapid reduction in the book value of an asset helps management identify when it is financially justifiable to replace old assets. This promotes efficiency and modernization in production facilities.
Accepted by Tax Authorities: The Income Tax Act in India recognizes the WDV method, allowing businesses to use the same calculation for both accounting and taxation purposes. This saves time and reduces reconciliation efforts.
Simplifies Long-Term Accounting: Once the rate is fixed, there is no need to revise calculations every year. The method offers consistency and simplicity in maintaining asset records over several accounting periods.
Provides Realistic Financial Statements: Because the book value of the asset decreases gradually and never becomes zero, it ensures that the balance sheet presents a realistic value of assets. This enhances the reliability of financial reporting.
Disadvantages of the WDV Method
Difficult Rate Calculation: Finding the accurate rate of depreciation requires the use of a formula involving scrap value, cost, and useful life. Many students and small businesses find this calculation confusing or time-consuming.
Residual Value Never Becomes Zero: Since depreciation is charged on a diminishing balance, the asset’s value never completely reduces to zero. In practice, the actual asset may have no value left, but the books still show a small amount.
Unsuitable for Assets with Uniform Utility: The method is not appropriate for assets such as buildings or furniture that provide equal service throughout their life. The Straight Line Method works better in such cases.
Complicated Ledger Maintenance: When multiple assets are acquired at different times, calculating depreciation for each item separately can be complex and time-consuming.
Inconsistent Expense Pattern: The annual depreciation charge decreases every year, which affects comparability of profits across different periods. Investors may find it difficult to evaluate performance trends when expenses keep declining.
Applicability of the WDV Method
The Written Down Value Method is mostly applied to plant and machinery, office equipment, vehicles, and tools. Manufacturing companies and industrial units use it frequently because these assets tend to wear out more quickly during the early years of use. It is also recommended for tax reporting purposes, as it aligns with prescribed accounting and taxation standards.
Conclusion
The Written Down Value Method provides a realistic approach to measuring how assets lose value over time. By applying a constant rate on the reducing balance, it ensures that the depreciation charge reflects the true pattern of asset usage. Businesses prefer this method because it balances simplicity, practicality, and compliance with accounting standards. Students and practitioners should remember that the accuracy of depreciation depends on understanding not just the formula but also the reasoning behind it. The WDV method remains a reliable and insightful way to measure the gradual decline in the worth of fixed assets.
