Straight-Line Method of Assets Depreciation
What Is the Straight-Line Depreciation Method?
Straight-line depreciation is the simplest of the various depreciation methods. Under this method, yearly depreciation is calculated by dividing an asset’s depreciable cost by its estimated useful life.
By far the most easily understood and widely used depreciation method is straight-line, under which an equal amount of depreciation is assigned to each year in the asset’s service life.
Under the straight-line method, the depreciable basis is divided by the number of years in the asset’s life in order to get the average annual expense.
This method is most appropriate when the cost assigned to each year is the same. this is the simplest and the most widely used method for calculating depreciation.
The depreciation expense in the straight-line method is calculated as follows:
Depreciation = (Cost of the asset – Residual value) / Number of years of useful life
It is advantageous to use the straight-line method when the usage of the asset in all the years is fairly uniform.
Explanation of the Straight-Line Method of Depreciation
To explain the straight-line method of depreciation, let’s assume the following data:
Using the above data, yearly straight-line depreciation is $7,200, calculated as follows:
(Cost – salvage value) / useful life = ($40,000 – $4,000) / 5 = $7,200
When the straight-line method is used, the depreciable cost of the asset is spread evenly over its life, in this case at a uniform rate of 20% (1 / 5 = 20%). Therefore, depreciation expense is the same each year, and by the end of the fifth year, the asset’s book value has been reduced to its estimated residual value of $4,000. Even if the equipment is still being used past the fifth year, it is left at its book value of $4,000. These points are summarized in the following schedule:
This example assumed that an entire year’s depreciation is taken in the year of acquisition. However, a firm purchases assets at different times during the year, and a full year’s depreciation need not taken on a partial year’s usage, Furthermore, depreciation is often calculated monthly or quarterly for the preparation of interim statements.
To illustrate the calculation of partial year’s depreciation, assume that in the above example the asset was purchased on April 1 rather than on January 2. In this case, only 9 months of depreciation expense, or $5,400 ($7,200 x 9/12), is recorded on December 31.
Straight-line depreciation is widely used because of its simplicity and the fact that it allocates an equal amount of expense to each period of the asset’s life. Even though from a conceptual perspective, straight-line depreciation is most appropriate for assets that give up their benefits en on a fairly uniform basis, management can choose straight-line depreciation, regardless of the pattern in which the asset gives up its benefits.
Below example shows the results of applying the method to this asset:
The annual amount is $105,000 divided by five years or $21,000 per year.
To illustrate the straight-line method of depreciation, assume that the cost of the asset is $50,000 with a useful life of 10 years. The depreciation expense for each year will be as follows:
50,000 / 10 = $5,000
In the above example, the depreciation rate can also be specified in terms of a percentage. A 10-year life indicates a depreciation rate of 1/10 or 10%. also, since the asset had an estimated useful life of 10 years, the depreciation expense each year was 1/10 of the depreciable amount. In actual practice, when it becomes difficult to estimate the residual value or the calculation of residual value is not material, depreciation can be calculated by simply dividing the cost of the asset by the number of years of estimated useful life.