Reducing Balance Method of Depreciation – Formula and Guide

Team Nomi

Mar 11, 2026
7 minutes read

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The reducing balance method of depreciation is a widely used accounting method for calculating the declining value of assets over time. It recognises that assets such as vehicles and machinery often lose value more quickly in their early years. 

Unlike the straight line method, which applies a constant annual amount, this method applies a fixed percentage to the asset’s net book value each year. As a result, depreciation charges are higher in the initial years and reduce as the asset ages.

This approach is particularly suitable for assets that become outdated quickly or are more productive when new. By reflecting the asset’s decreasing efficiency and rising maintenance costs over time, it provides a realistic view of its economic value and supports accurate financial reporting and tax planning.

What is Depreciation?

Depreciation is an accounting concept that represents the gradual reduction in the value of a tangible asset over its useful life. This decrease in value occurs due to wear and tear, age, usage, and technological obsolescence.

Instead of recording the full cost of an asset in the year of purchase, businesses spread the cost across the years it is expected to be used. This follows the matching principle, ensuring expenses are recognised in the same period as the revenue generated.

For example, if a company purchases machinery for £10,000, it would allocate part of that cost each year over its useful life rather than expensing £10,000 immediately. Depreciation is essential for:

• • Preparing statutory accounts
  • Accurate profit calculation
  • Budgeting and forecasting
  • Asset valuation on the balance sheet

What is the Reducing Balance Method of Depreciation?

The reducing balance method of depreciation calculates depreciation by applying a fixed percentage to the asset’s book value at the start of each year. This approach is also referred to as the reducing balance method of depreciation.

Unlike the straight line method, which spreads cost evenly, this method results in:

• • Higher depreciation in early years
  • Lower depreciation in later years

Example

If a £10,000 asset has a 20% depreciation rate:

• • Year 1: £10,000 × 20% = £2,000
  • Year 2: £8,000 × 20% = £1,600
  • Year 3: £6,400 × 20% = £1,280

Depreciation is reduced each year because it is calculated on the remaining book value.

This method is commonly used for:

• • Vehicles
  • IT equipment
  • Plant and machinery
  • Tools and specialist equipment

Differences Between Straight Line and Reducing Balance Methods

When choosing a depreciation method, businesses must select the one that best reflects how an asset loses value over time. The straight line and reducing balance methods are the two most commonly used approaches in UK accounting. 

While both achieve the same goal of allocating an asset’s cost over its useful life, they differ in how depreciation is calculated and how expenses are recognised each year.

Straight Line Method

• • Constant depreciation amount each year
  • Based on initial cost minus residual value
  • Book value reduces evenly
  • Simple to calculate
  • Suitable for assets with predictable usage

Reducing Balance Method

• • Decreasing depreciation amount each year
  • Based on the opening book value annually
  • Book value reduces progressively but rarely reaches zero without adjustment
  • Better reflects real usage patterns
  • More detailed calculation required

Both methods are acceptable under accounting standards, provided the chosen method reflects the asset’s pattern of economic benefits.

How to Calculate Depreciation Using the Reducing Balance Method

Calculating depreciation using the reducing balance method involves applying a fixed percentage to the asset’s book value each year. This results in higher depreciation in the early years and gradually lower amounts over time.

Required Information for Calculation

To calculate depreciation using the reducing balance method, you need the following information:

• • Original Value of the Asset: The initial purchase cost of the asset.

• • Depreciation Rate: The fixed percentage rate at which the asset will depreciate each year.

• • Residual Value: The estimated value of the asset at the end of its useful life (optional, but useful for more accurate calculations).

Reducing Balance Depreciation Formula

The standard depreciation formula under this method is:

Depreciation = Net Book Value × Depreciation Rate

Where:

• • Net Book Value = Value at the beginning of the year
  • Depreciation Rate = Fixed annual percentage

If residual value is considered:

Depreciation = (Net Book Value − Residual Value) × Depreciation Rate

This is the core reducing balance depreciation formula used in UK financial reporting.

Example Calculation

Scenario: XYZ Limited purchased a truck for £75,000. Depreciation rate is 20% per year.

Year 1
Net Book Value: £75,000
Depreciation: £75,000 × 20% = £15,000
Closing Book Value: £60,000

Year 2
Net Book Value: £60,000
Depreciation: £60,000 × 20% = £12,000
Closing Book Value: £48,000

Year 3
Net Book Value: £48,000
Depreciation: £48,000 × 20% = £9,600
Closing Book Value: £38,400

This demonstrates how depreciation by the reducing balance method results in decreasing annual charges.

Advantages of the Reducing Balance Method

The reducing balance method is often chosen when businesses want depreciation to reflect how assets actually lose value in practice. It is particularly useful for assets that decline quickly in their early years or become outdated due to technological changes.

• • Accurately reflects real-world asset value decline
  • Aligns expenses more closely with revenue generated in early years
  • Higher initial depreciation can lower early accounting profit
  • Offsets rising maintenance and repair costs over time
  • Encourages businesses to review and replace ageing assets
  • Allows flexibility in selecting appropriate depreciation rates

Many UK SMEs prefer this method for technology-intensive operations where assets quickly become outdated.

Disadvantages of the Reducing Balance Method

While effective, this method may not suit every business. Higher early charges and more detailed calculations can affect financial reporting and require careful planning.

• • Higher initial depreciation reduces the early reported profit
  • More complex to calculate compared to a straight line
  • Book value does not usually reduce fully to zero without adjustment
  • May misrepresent profit if the asset’s usage pattern differs
  • Requires careful selection of the depreciation rate to avoid distortion

When to Use the Reducing Balance Method?

The reducing balance method of depreciation is suitable when:

• • Assets lose value quickly in the early years
  • Technology becomes obsolete rapidly
  • Vehicles or machinery depreciate faster initially
  • Businesses want depreciation aligned with usage
  • Maintenance costs increase over time
  • Accelerated accounting depreciation better reflects commercial reality

Businesses should ensure the chosen method complies with applicable accounting standards and remains consistent year to year unless there is a justified reason for change.

Conclusion

While depreciation is used in financial statements, tax relief is claimed through capital allowances, such as the Annual Investment Allowance (AIA) or Writing Down Allowances, subject to eligibility rules set by HM Revenue & Customs.

Businesses must not confuse accounting depreciation with tax deductions. Always ensure alignment between your accounting policy and tax treatment.

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Frequently Asked Questions

1. How do you calculate reducing balance depreciation?
   Ans. Reducing balance depreciation is calculated by applying a fixed percentage to the asset’s opening book value each year using the formula: Depreciation = Net Book Value × Depreciation Rate.
2. What are the 4 methods of depreciation?
   Ans. The four common methods are the straight line method, the reducing balance method, the units of production method, and the sum of the years’ digits method.
3. Can a company use two different depreciation methods?
   Ans. Yes, a company can use different depreciation methods for different types of assets, as long as each method reflects the asset’s pattern of economic benefit and is applied consistently.
4. What is the reducing balance method also known as?
   Ans. The reducing balance method, also known as the diminishing balance method or declining balance method, is used to calculate depreciation.
5. How to calculate interest using the reducing balance method?
   Ans. Interest under the reducing balance method is calculated on the outstanding loan principal each period, meaning interest reduces over time as the principal amount decreases.