Written down Value Method, Features, Advantages, Limitations

Written Down Value Method is a depreciation method where a fixed percentage is applied to the asset’s book value (not the original cost) at the beginning of each year. Since the book value reduces every year, the depreciation amount also decreases annually.

This method recognizes that assets are often more productive and valuable in the early years of their life, hence charging higher depreciation initially and lower amounts in later years.

Formula

Depreciation for the year = Opening Book Value × Depreciation Rate

Example

• Asset Cost: ₹1,00,000

• Depreciation Rate: 20% per annum

Year 1: ₹1,00,000 × 20% = ₹20,000
Year 2: ₹80,000 × 20% = ₹16,000
Year 3: ₹64,000 × 20% = ₹12,800
(And so on…)

Features of Written down Value Method:

• Depreciation on Book Value

In the WDV method, depreciation is calculated on the book value (i.e., the reduced value) of the asset at the beginning of each year, not on its original cost. As depreciation is deducted each year, the value of the asset keeps decreasing, and depreciation is applied on this reduced value in the subsequent years. This approach reflects a more realistic reduction in the asset’s worth and aligns with the declining efficiency or usage of many fixed assets.

• Depreciation Amount Declines Over Time

One of the hallmark features of the WDV method is that the depreciation amount decreases every year. Since the rate is applied to the reducing book value, each successive year records a lower depreciation expense. This is especially appropriate for assets that lose a larger portion of their value in the early years of use. It also mirrors the fact that most assets tend to generate higher benefits in the beginning and gradually reduce their utility over time.

• Book Value Never Becomes Zero

Under the WDV method, the asset’s book value never becomes zero, no matter how long depreciation is applied. This is because the depreciation is based on a percentage of the reducing balance, not a fixed deduction. Therefore, there is always a remaining value, however small. This characteristic often necessitates a manual write-off or adjustment in the final year of the asset’s life to bring the asset’s value to its residual or scrap value.

• Encourages Early Cost Recovery

This method helps businesses recover more cost in the early years when the asset is more productive. By allowing higher depreciation in the initial years, it reduces taxable income during the early years of asset usage. This feature aligns well with the real-world wear and tear of many capital assets and provides a better matching of expense with revenue generation. It’s especially advantageous in capital-intensive industries with rapid technological changes.

• Commonly Accepted for Tax Purposes

The WDV method is widely accepted under tax laws in many countries, including India, where the Income Tax Act prescribes WDV as the standard method for depreciation. This makes it a preferred choice for businesses looking to align their financial accounting and tax reporting. The method’s accelerated depreciation benefit helps lower taxable profits in the early years, offering tax savings and better cash flow management during crucial business phases.

• Reflects Asset’s Actual Usage Pattern

Since assets typically offer more utility in the initial years, the WDV method better reflects their usage and efficiency patterns. For instance, machinery and vehicles often function at their best early on and may require more maintenance or yield lower performance later. Applying a decreasing depreciation pattern in line with their actual condition and performance results in a more accurate portrayal of the asset’s consumption and its effect on profitability.

• More Complex Than Straight Line Method

Compared to the Fixed Installment (Straight Line) method, WDV involves more complex calculations. Each year’s depreciation must be calculated afresh using the book value of the asset at the start of the year. This requires careful record-keeping and increases the likelihood of manual errors if done without software. However, modern accounting systems typically handle such calculations efficiently, reducing the method’s operational difficulty in today’s business environments.

• Suitable for Rapidly Obsolescent Assets

The WDV method is ideal for assets that depreciate rapidly or become obsolete quickly, such as electronic equipment, computers, and vehicles. These assets tend to lose their value quickly due to technological advancements or heavy usage. The higher depreciation charged in the initial years under this method helps present a more accurate financial position, ensuring that asset values shown in the balance sheet are neither overstated nor misleading over time.

Advantages of Written down Value Method:

• Reflects Actual Asset Usage

The WDV method closely aligns with the actual decline in value of most fixed assets. Assets typically provide more value in the initial years and less as they age. By applying a higher depreciation rate early on, this method mirrors real-world wear and tear, offering a realistic reflection of the asset’s declining utility. It ensures that depreciation matches the usage and performance of the asset over time, improving the accuracy of financial statements.

• Suitable for Technology-Driven Assets

The WDV method is ideal for assets that rapidly become obsolete, such as electronics, machinery, and vehicles. These assets lose significant value in the early years of use, and the method accommodates this by charging higher depreciation initially. It helps avoid overstating the value of such assets on the balance sheet. This feature makes it especially relevant for industries experiencing fast technological advancement or where products are replaced frequently.

• Provides Tax Benefits in Early Years

Because this method charges higher depreciation in the early years, it reduces taxable income during those years. This results in lower tax liability and better cash flow when the business might need it the most — such as during the launch of a new project or capital investment phase. Many tax laws, including India’s Income Tax Act, recognize WDV as a standard method, providing businesses with a tax-compliant approach that also offers financial relief.

• Facilitates Faster Cost Recovery

The accelerated nature of WDV allows businesses to recover asset costs more quickly. Since a larger portion of an asset’s cost is charged to expenses in the early years, the method supports a faster return of the initial investment. This is beneficial from both a financial and accounting perspective. It enhances liquidity and encourages reinvestment by releasing more funds earlier in the asset’s life cycle.

• Encourages Conservative Financial Reporting

By recognizing higher expenses in the early years, the WDV method promotes conservative accounting practices. It avoids inflating profits and provides a more cautious view of the company’s financial health, which is favored by investors and auditors. This conservatism also protects against potential losses from asset obsolescence, ensuring that the balance sheet reflects a prudent and realistic valuation of the firm’s long-term assets.

• Consistent with Physical Deterioration

Most physical assets lose their efficiency, output, or reliability as they age. The WDV method accommodates this natural decline by reducing the depreciation amount in line with the asset’s declining performance. This results in more accurate matching of expense to income, especially in operational contexts where asset performance affects productivity. It provides a truer picture of operating costs and supports better management decisions regarding asset utilization.

• Reduces Book Value to Realistic Levels

This method ensures that the asset’s book value decreases steadily and rarely overstates the asset’s worth. In contrast to the Straight Line Method, where the asset might appear too valuable even in its last years, the WDV method gives a more realistic asset valuation. This helps stakeholders — such as lenders, investors, and auditors — better assess the company’s financial position and the remaining economic utility of its fixed assets.

• Widely Accepted for Tax and Audit Purposes

The WDV method is widely accepted by tax authorities and auditors, making it convenient for businesses to maintain compliance. In India and many other countries, WDV is the prescribed depreciation method under income tax laws. This saves companies from the burden of maintaining separate sets of books for accounting and tax purposes. It also simplifies audit procedures, as the method is familiar and well-supported by both financial and legal frameworks.

Disadvantages of Written down Value Method:

• Complex Calculations Every Year

The WDV method involves recalculating depreciation each year based on the reduced book value, unlike the fixed amount in the straight-line method. This requires maintaining detailed records and performing fresh calculations annually, which can be time-consuming and prone to errors in manual systems. Without computerized accounting software, this complexity may lead to inconsistencies, making the method less suitable for small businesses or those lacking adequate accounting expertise.

• Asset Value Never Becomes Zero

One major limitation of the WDV method is that the asset’s value never reduces to zero, even after many years of depreciation. Since depreciation is applied to the diminishing balance, a small portion of the asset’s value always remains on the books. This means that a manual adjustment or disposal entry is eventually required to clear the asset’s residual value, adding to accounting work and creating complications in asset disposal or write-off procedures.

• Uneven Impact on Profits Over Years

The method results in higher depreciation in early years and lower in later years, which causes profit fluctuations. Profits may appear artificially low in initial years and inflated in later years, distorting the company’s true financial performance. This inconsistent profit trend can affect management decisions, dividend planning, and investor perception. Stakeholders may struggle to interpret financial trends accurately if depreciation does not match stable operational outputs.

• Inappropriate for Uniform Utility Assets

The WDV method is not suitable for assets that provide equal benefits over their lifespan, such as office buildings or furniture. In such cases, applying higher depreciation in the early years does not reflect actual usage, leading to misrepresentation of asset value and income matching. For uniformly used assets, the Straight Line Method offers a better depiction of cost allocation and ensures a more accurate match between revenue and expense.

• Hinders Long-Term Financial Planning

The declining depreciation expense under the WDV method creates inconsistent cost patterns over the years. This inconsistency can complicate long-term budgeting, financial forecasting, and performance analysis. Management may face difficulty in projecting future costs accurately or comparing year-to-year financial results. As businesses rely on stable cost structures for strategic planning, the fluctuating depreciation figures under WDV might hinder effective decision-making and financial control.

• Not Suitable for Short-Term Assets

The WDV method is ineffective for assets with short useful lives. Since the depreciation amount is higher initially and declines each year, short-term assets might not depreciate enough before becoming obsolete. This could leave a significant un-depreciated value on the books, causing financial statements to overstate asset worth. For such assets, the fixed installment or 100% depreciation in a single year is often more practical and reflects a truer cost pattern.

• May Lead to Understatement of Expenses in Later Years

As depreciation under the WDV method continues to decline, the recorded expenses may become disproportionately low compared to the actual maintenance costs or reduced performance of the asset. This could lead to understatement of total operational costs, especially in later years when repair and maintenance expenses typically increase. This mismatch may result in distorted cost analysis and misinformed managerial decisions regarding asset replacement or usage.

• Challenges in Comparative Analysis

The uneven depreciation charges from year to year make comparative financial analysis difficult, both within the company and with competitors using different methods. Since the depreciation trend is not linear, comparing profitability, efficiency, and return on assets over time can be misleading. External stakeholders such as investors and analysts may find it challenging to interpret financial statements accurately, particularly if disclosure of the depreciation method is not transparent.

Comparison between the Written Down Value (WDV) Method and Straight Line Method (SLM)