Assets and depreciation
Diminishing value method
The diminishing value method gives larger depreciation deductions in the early years by applying a fixed percentage each year to the asset's remaining value instead of its original cost.
The diminishing value method is the second way to calculate the decline in value of a depreciating asset. It front-loads deductions, so you claim more in the early years and progressively less as the asset's remaining value, called its opening adjustable value, decreases. It reflects the fact that many assets lose more value early in life.
For assets acquired after 10 May 2006, the formula multiplies the asset's base value by the days held divided by 365, and then by 200% divided by the effective life in years. For example, a five-year effective life gives an annual rate of 40% of the opening value, while a ten-year life gives 20%. The base value is the cost in the first year, and in later years it is the cost less deductions already claimed.
Because the deduction is a percentage of a reducing balance, the asset is never fully written off by the formula. In practice, the remaining balance can be dealt with when the asset is sold, lost, scrapped, or ceases to be used, through a balancing adjustment. Some assets also move into the small business pool or the low-value pool, which have their own rates.
The method is attractive for assets that wear out or become outdated quickly, such as computers and vehicles, and for businesses that want bigger deductions soon after buying. However, total deductions over the full life are the same as under the prime cost method. The difference is only in timing. You choose the method for each asset, and it generally cannot be changed.
GST is independent of the method. A registered business generally claims the full GST credit on the purchase in the BAS for the period of the tax invoice, and the GST-exclusive cost is the amount that depreciates. On sale, GST is generally payable if the business is registered. For cars, the car limit may cap both the depreciable cost and the GST credit.
Typical errors include applying the rate to the original cost in later years instead of the reduced balance, and forgetting to reduce the deduction for private use. This is general information only, so confirm your situation with the ATO or a registered tax professional.
Worked example
A registered business buys a computer for $3,300 including GST on 1 July. The GST credit is $300, and the GST-exclusive cost is $3,000. Assume a 4-year effective life, so the rate is 200% / 4 = 50%. Year one deduction is $3,000 x 50% = $1,500. Remaining value is $1,500. Year two deduction is $1,500 x 50% = $750, leaving $750.
Practical tips
- Apply the percentage to the reducing balance each year, not to the original cost.
- Remember the total deduction over the full life is the same as prime cost, since only the timing differs.
- Reduce the deduction for any private use of the asset.