What is reducing balance depreciation?

Each year you multiply the asset's opening written-down value (cost less the depreciation already charged) by a fixed rate. Because the base shrinks every year, so does the charge: year one is calculated on the full cost, year two on what is left, and so on. The written-down value never quite reaches zero on its own, so for accounting you stop at the residual (scrap) value your policy sets, and on disposal you compare the proceeds with the written-down value to find the gain or loss.

Under ATO rules the rate for most assets is 200% divided by the effective life, unless a specific statutory rate applies, and the ATO's wording is opening adjustable value multiplied by the rate multiplied by days held over 365. Compared with straight-line, diminishing value front-loads the expense and leaves a written-down balance at the end, which the balancing adjustment squares up on disposal.

For tax, the capital allowance rules generally let you choose diminishing value or prime cost for each asset. Diminishing value brings deductions forward, which helps early cashflow; prime cost is simpler and steadier, and suits assets that deliver even benefits over time, such as buildings and some furniture. For tax the choice is made once per asset and cannot be changed for that asset, so it matters at the point of first use. The accounting treatment can be revised as a change in estimate, provided you document the change.

Small business entities may use the simplified depreciation rules instead, including pooling and the instant asset write-off where the thresholds allow. Confirm the effective life you are using against the ATO's tables, because using the ATO's figure avoids disputes, and remember that residual value is treated differently for tax than in the accounts.

Keep the purchase invoice, the effective life rationale, the calculation schedule and the days-held basis for the first and last year, and reconcile accumulated depreciation to your asset register at year end. A spreadsheet or fixed-asset module will generate the written-down value schedule for you once you enter the cost, effective life and rate.

If the asset is financed, depreciation relates to the asset's cost, not the finance: track the interest and principal separately. The equipment finance or asset finance structure you choose can affect how you capitalise and manage the asset, so factor it in when comparing diminishing value with prime cost.