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Business Strategy and Accounting Basics

Manufacturing equipment with an acquisition cost of ¥10 million is depreciated by the declining-balance method with a rate of 0.4 (ignoring any switch of method based on a guaranteed depreciation amount). Which is its book value at the end of the second year?

  1. A¥2 million
  2. B¥3.6 million
  3. C¥6 million
Show answer and explanation

Answer: B. ¥3.6 million

The declining-balance method multiplies the book value at the beginning of each year by the same rate to get the depreciation for that year. In year 1 it is 10 × 0.4 = ¥4 million, leaving a book value of ¥6 million; in year 2 it is 6 × 0.4 = ¥2.4 million, leaving a book value of 6 − 2.4 = ¥3.6 million. The expense is largest in the first years and shrinks over time, which is considered closer to reality for equipment whose value falls quickly because technology advances fast.

  • A. This assumes ¥4 million, the acquisition cost times the rate, is depreciated every year. In the declining-balance method the rate is applied to the book value at the beginning of the year (¥6 million in year 2).
  • B. Correct. It is 10 × (1 − 0.4)² = ¥3.6 million.
  • C. This is the book value at the end of the first year.
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