Declining-balance multiplication factor

Updated May 18, 2018

Dear SAP Gurus,

I am on the step of Define Declining-Balance Methods - tcode AFAMD.

In that a column for defining Declining-balance multiplication factor.

I want to understand the logic for defining multiplication factor, we have to define numeric values here in this column, but i don't understand on which basis we define values in this column.

Would appreciate ur king help to solve my issues.

Regards,

Comments

30 Jun 2010 6:42 am Shalesh Singh Visen Best Answer
Let us first understand the concept of depreciation.

You must be aware that depreciation is the process of expensing out a fixed
asset ( viz. reduce the value of the asset in the balance sheet and post it
as an irrecoverable loss / expense in the balance sheet) over the estimated
life of such asset.

There are many such methods to expense out an asset.

The simplest of them would be the straight line method which distributes the
asset value in a *linear* fashion and equi-distributes the depreciation over
the estimated life of the asset.

Asset Value on procurement : 100 units depreciated as

(straight line method if the life of the asset is 4 years: 25+25+25+25 ) 25
% depreciation for 4 years

(straight line method if the life of the asset is 5 years: 20+20+20+20+ 20 )
20 % depreciation for 5 years

The other method is declining balance method which depreciates more during
the initial years of the asset and depreciates less as time progresses. To
quote an example, don't you try to save more of your earnings while young
and use such savings during your old age when you have retired from work?
Likewise, a fixed asset is depreciated more during its early useful and
functional life so that you have provided for enough when the asset slowly
starts losing its functionality as time progresses. This method is *non-
linear*.

Declining balance method depreciates more when the asset is most useful and
fully functional ( viz. during earlier years from the date of acquisition ).
This method can be expressed as a multiple of straight line method. The
multiple is called a *factor*. Usually the multiple would be 2 or 2.5 or 3
which means that your depreciation would be 2 to 3 times more under this
method as compared to the straight line method . This is just to accelerate
the initial depreciation so that you have earmarked a sizable portion of
your initial profits for smooth replacement of the asset when your asset
might start losing its sheen in terms of functionality. This is called
accelerating the depreciation.

Though you can devise your own factors such as 6 and 7 ( in place of 2 or 3
), you do not do so for the simple reason that excessive depreciation in the
initial periods with an abnormally high factor of 6 or 7 can affect
consistency of your annual profits in terms of quantum which is not
appreciated by tax authorities and other stake holders.

Let us imagine that you are depreciating an asset of 100 units ( 5 year life
) with 6 factor. This would result in a decrease in the profit by 60 units
in the first year ; the second year's profit would decrease by 24 units ( 40
* 10/100 * 6).

The wide margin in the annual profit happening in your organization would

a. distort estimation of tax liability,

b. distort dividend declaration to share holders,

c. affect comparative analysis of profit across years within the
organization

d. make comparative analyses across company codes difficult

In order to avoid this, you try not to use a factor of more than 3 or so by
which you accelerate your depreciation and yet keep your annual profits
consistent.

Now, do you understand the logic behind the factor used in declining balance
method?

Regards

10 Apr 2014 12:12 am Guest Helpful Answer

to me it looks like instead of 5 years it should be 10 years , only than that calculation makes sense.

(1/10)*6=0.6 so 0.6*100=60

30 May 2010 3:01 am Shalesh Singh Visen
As per my understanding from below reply "factor" is decided as per requirement of company by company itself.

Also u mentioned that 6 or 7 factor will lead to more depreciation in comparison of 2 or 3 which is not appreciated by tax authorities, it means these factors are also defined by gov. also or not.

Pls correct if my understanding is wrong.

30 Jun 2010 6:43 am Shalesh Singh Visen
As per my understanding from below reply "factor" is decided as per requirement of company by company itself.

Also u mentioned that 6 or 7 factor will lead to more depreciation in comparison of 2 or 3 which is not appreciated by tax authorities, it means these factors are also defined by gov. also or not.

Pls correct if my understanding is wrong.