The accounting process involves various methods of adjusting financial information so that it reflects your company's activity as realistically as possible. Depreciation, such as 200 DB, is one such method that allows accountants to add a fractional part of a large, expensive asset's cost to their profit and loss statement over a span of years. This serves to spread the expense of the asset over time instead of having a very large expense in one year.
Instead of a company showing a $120,000 equipment expense all in one year, for example, the expense is shown over the five-year life of the equipment, as determined by the IRS. This helps offset an appropriate amount of the expense against revenue over the equipment's useful life, in keeping with the revenue-and-expense-matching-principle. The matching principle says that revenue earned in a given time period should be offset against the expenses incurred to generate the revenue from that same time period. If the $120,000 equipment has a five-year life, then one-fifth of it gets depreciated each year as an expense that reduces whatever revenue it helped generate in that year. This method of depreciation, where the cost of an asset gets divided and depreciated evenly over its useful life, is known as straight-line depreciation.
The expression 200 DB stands for 200 percent declining balance, also known as double-declining-balance depreciation (DDB). This type of depreciation differs from the standard, straight-line depreciation in a few ways. Companies have the option to accelerate the depreciation of an equipment expense, which helps lower profits to reduce income taxes. For example, a $120,000 piece of equipment with a five-year life would still be depreciated over five years with DDB depreciation, but the amounts would be significantly larger in the first few years.
Even though various assets have a predetermined useful life for depreciation purposes, at times the asset still has some value remaining at the end of its useful life. This value, known as salvage value, is typically the amount the company expects it can sell the asset for at the end of its useful life. When calculating straight-line depreciation, you can only depreciate the amount of the asset's original cost, minus its salvage value. So, for a $120,000 machine with a salvage value of $20,000 after five years, you would use $100,000 for your straight-line depreciation calculation. On the other hand, DDB depreciation works differently: you would start with the asset's full value, $120,000, and apply your annual calculation to depreciate the asset until its remaining book value equals its $20,000 salvage value.
The DDB depreciation calculation uses straight-line depreciation as its starting point. For this example, we will assume the asset has zero salvage value at the end of its life.
Straight-line depreciation = Initial equipment cost ÷ useful life
For example: $120,000 equipment cost ÷ 5 year useful life = $24,000 annual depreciation
Since the asset has a useful life of five years, one-fifth or 20 percent of its value gets depreciated each year.
For the DDB depreciation calculation, first multiply the straight-line depreciation percentage by two to find the percentage of the asset you can depreciate in each period:
Straight-line depreciation percentage x 2 = (1 ÷ 5-year life) x 2 = 40 percent
The application of the 40 percent DDB depreciation works differently than straight-line depreciation. In this scenario, you would still depreciate your asset over five years. In the first depreciation year, you would take 40 percent of your asset's value as depreciation. However, the next year you would depreciate 40 percent of the asset's remaining balance, and repeat this process until the remaining value of your asset equals its salvage value or zero if the asset has no salvage value.