How do straight-line and double-declining-balance depreciation affect financial statements differently?
For CFA Level I, I need to understand how choosing between straight-line (SL) and double-declining-balance (DDB) depreciation changes the numbers on the income statement and balance sheet over time. I know DDB front-loads the expense, but I'm unclear on the crossover point and how it affects ratios in early vs. late years.
Straight-line (SL) and double-declining-balance (DDB) depreciation produce the same total depreciation over an asset's life, but they allocate it very differently across periods.
Example: Oakmont Manufacturing buys equipment for $100,000 with a 5-year useful life and $0 salvage value.
Straight-Line:
Annual depreciation = ($100,000 − $0) / 5 = $20,000 per year
Double-Declining-Balance:
DDB rate = 2 x (1/5) = 40%
| Year | Beginning BV | DDB Expense | Ending BV |
|---|---|---|---|
| 1 | $100,000 | $40,000 | $60,000 |
| 2 | $60,000 | $24,000 | $36,000 |
| 3 | $36,000 | $14,400 | $21,600 |
| 4 | $21,600 | $11,600* | $10,000 |
| 5 | $10,000 | $10,000* | $0 |
*Years 4-5 switch to SL to fully depreciate (DDB would give $8,640 and $5,184, leaving undepreciated residual).
Financial Statement Effects:
| Metric | Early Years (DDB vs SL) | Later Years (DDB vs SL) |
|---|---|---|
| Depreciation expense | Higher | Lower |
| Net income | Lower | Higher |
| Total assets (net BV) | Lower | Higher |
| ROA | Lower numerator, lower denominator | Higher numerator, higher denominator |
| ROE | Lower | Higher |
| CFO | Same (depreciation is non-cash) | Same |
The crossover point occurs around mid-life when DDB expense drops below SL expense. After this point, the DDB company looks more profitable even though nothing economic has changed.
Exam tip: When comparing two companies using different methods, always check if the asset base is young or old. A company using DDB with mostly new assets will appear less profitable than one using SL, even if their operations are identical. Analysts should look at total depreciation over the asset's life, not just a single year.
Check out our CFA Level I FRA course for interactive depreciation comparison tools.
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