Straight line depreciation is the most commonly used and straightforward depreciation method for allocating the cost of a capital asset. It is calculated by simply dividing the cost of an asset, less its salvage value, by the useful life of the asset. The estimated useful life value used in our calculations are for illustration purposes. If you are calculating depreciation value for tax purposes, you should get the accurate, useful life figure from the Internal Revenue Agency (IRS). A fixed asset account is reduced when paired with accumulated depreciation as it is a contra asset account.
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- This method first requires the business to estimate the total units of production the asset will provide over its useful life.
- This article covered the different methods used to calculate depreciation expense, including a detailed example of how to account for a fixed asset with straight-line depreciation expense.
- Let’s break down how you can calculate straight-line depreciation step-by-step.
- Additionally, the straight line basis method does not factor in the actual physical rapid loss of an asset’s value in the early years of its life.
For example, the risk of an asset becoming obsolete earlier than anticipated due to the transformative nature of innovative technology is not considered. Try to use common sense when determining the salvage value of an asset, and always be conservative. Don’t overestimate the salvage value of an asset since it will reduce the depreciation expense you can take. Let’s break down how you can calculate straight-line depreciation step-by-step. We’ll use an office copier as an example asset for calculating the straight-line depreciation rate.
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This is machinery purchased to manufacture products for the business to sell. Since the equipment is a tangible item the company now owns and plans to use long-term to generate income, it’s considered a fixed asset. This method is calculated by adding up the years in the useful life and using that sum to calculate a percentage of the remaining life of the asset. The percentage is then applied to the cost less salvage value, or depreciable base, to calculate depreciation expense for the period. Because organizations use the straight-line method almost universally, we’ve included a full example of how to account for straight-line depreciation expense for a fixed asset later in this article.
With straight-line depreciation, you must assign a “salvage value” to the asset you are depreciating. The salvage value is how much you expect an asset to be worth after its “useful life”. Therefore, Company A would depreciate the machine at the amount of $16,000 annually for 5 years.
- It assumes that the asset’s value diminishes equally over each accounting period during its useful life.
- Estimated Useful Life of Asset is the estimated time or period that an asset is perceived to be useful and functional from the date of first use up to the day of termination of use or disposal.
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- Straight line depreciation is the easiest depreciation method to calculate.
One convention that companies embrace is referred to as depreciation and amortization. Accountants commonly use the straight line basis method to determine this amount. To calculate the straight line basis, take the purchase price of an asset and then subtract the salvage value, its estimated sell-on value when it is no longer expected to be needed. Then divide the resulting figure by the total number of years the asset is expected to be useful, referred to as the useful life in accounting jargon.
Advantages and Disadvantages of Straight Line Basis
The machine is estimated to have a useful life of 10 years and an estimated salvage value of $2,000. Estimated Useful Life of Asset is the estimated time or period that an asset is perceived to be useful and functional from the date of first use up to the day of termination of use or disposal. So, the company will record depreciation expense of $7,000 annually over the useful life of the equipment. Now, consider an example to illustrate the straight-line method depreciation for a fixed asset.
The convention is meant to match sales and expenses to the period in which they occurred, as opposed to when payment was made or collected. With this cancellation, the copier’s annual depreciation expense would be $1320. Depending on how often they are used, different assets can wear out at different rates, and any method of calculating depreciation value may come in handy. A company building, for example, is being used equally and consistently every day, month and throughout the year. Therefore, the depreciation value recorded on the company’s income statement will be the same every year of the building’s useful life.
Step 5: Multiply Your Depreciation Rate by the Asset’s Depreciable Cost
The straight line basis simply allocates the expense equally into each period of its useful life, which smooths the expense and ultimately net income. The straight line basis is a method of calculating depreciation and amortization. The straight line basis is the simplest way to work out the loss of value of an asset over time. This method allows businesses and individuals to prepare for the future without having to take too much time or effort. It is calculated by dividing the difference between an asset’s cost and its expected salvage value by the number of years it is expected to be used.
You can then depreciate key assets on your tax income statement or business balance sheet. Calculating the depreciating value of an asset over time can be tedious. Many accountants, though, tend to use a simple, easy-to-use method called the straight line basis. This method spreads out the depreciation equally over each accounting period.
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Still, the straight-line depreciation method is widely employed for its simplicity and functionality to determine the depreciation of assets being used over time without a particular pattern. In some scenarios, subsequent journal entries may change due to adjustments to the fixed asset’s useful life or value to the company as a result of improvements or impairments of the asset. For example, during year 5 the company may realize the asset will only be useful for 8 years instead of the originally estimated 10 years. The prior depreciation expense cannot be changed as it was already reported.
The term “double-declining balance” is due to this method depreciating an asset twice as fast as the straight-line method of depreciation. The “2” in the formula represents the acceleration of deprecation to twice the straight-line depreciation amount. However, when using the declining balance method of depreciation, an entity is not required to only accelerate depreciation by two. They are able to choose an acceleration factor appropriate for their specific situation. Depreciation is a way to account for the reduction of an asset’s value as a result of using the asset over time. Depreciation generally applies to an entity’s owned fixed assets or to its leased right-of-use assets arising from lessee finance leases.
The straight-line method is the most common method used to calculate depreciation expense. It is the simplest method because it equally distributes the depreciation expense over the life of the asset. Thus, Company X only needs to expense $950 instead of writing off the asset’s full cost in the current accounting period, which is what would happen under the cash basis of accounting. Furthermore, the company will continue to expense $950 annually until the book value of the asset reaches the salvage value of $1,500. The next step in the calculation is simple, but you have to subtract the salvage value. Straight line depreciation is a common method of depreciation where the value of a fixed asset is reduced over its useful life.