What Is Straight-Line Depreciation? Definition, Formula and Examples

You would use straight-line depreciation during the time that you own the asset and take a deduction for this portion of the total cost, and then switch to MACRS depreciation when you sell the asset. This method is one of the easiest ways to calculate an asset’s depreciation expenses and yields fewer errors over the life of the asset. Residual value is the estimated value of a fixed asset at the end of its lease term or useful life. Cash And Cash EquivalentsCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation. Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. We can also calculate the depreciation rate, given the annual depreciation amount and the total depreciation amount, which is the annual depreciation amount/total depreciation amount.

Straight-line depreciation can be recorded as a debit to the depreciation expense account. It can also be a credit to your accumulated depreciation account.

Disadvantage of Straight Line Depreciation

Assuming a fiscal year ending December 31, under the half-year convention the asset is considered to have been put into service on July 1st of the year. If an asset has a useful life of 5 years, then one-fifth of its depreciable cost is depreciated each year.

At the end of the 10 years, the company expects to receive the salvage value of $30,000. In this example, the straight-line depreciation method results in each full accounting year reporting depreciation expense of $40,000 ($400,000 of depreciable cost divided by 10 years). The straight line depreciation method is the simplest form of depreciation https://simple-accounting.org/ because it allocates an equal amount of costs for each accounting period in the asset’s useful life. The straight line depreciation formula is computed by dividing the total asset cost less the salvage value by the number of periods in the asset’s useful life. This amount will be recorded as an expense each year on the income statement.

How to Calculate Straight Line Depreciation

We only need to estimate the residual value of the assets and the years of economic life. Straight-line depreciation is a very useful method that allows one to depreciate an asset evenly over time at a set rate. In other words, it is a systematic way of calculating depreciation deductions in equal amounts for each unit of the asset during its useful life.

The cost of an asset is the amount that was paid to purchase it, while the salvage value is the estimated value of the asset at the end of its useful life. The useful life of an asset refers to the total amount of time that it can be used before being replaced or retired. Using the formula to calculate these figures provides the annual depreciation expense, which is a measure of the amount by which an asset’s value declines each year. Straight-line depreciation is a method of determining the amortization and depreciation of an asset. This calculation allows companies to realize the loss of value of an asset over a period of time. This type of depreciation method is easy to use and is highly recommended for companies which to calculate depreciation in a simple and effective manner.

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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. This lease qualifies as a finance lease because it is written in the agreement that ownership of the Straight Line Depreciation Method Definition, Examples equipment automatically transfers to Reed, Inc. when the lease terminates. To evaluate the lease classification, we used the capital vs. operating lease criteria test. Below we will describe each method and provide the formula used to calculate the periodic depreciation expense.

Accountants use the straight line depreciation method because it is the easiest to compute and can be applied to all long-term assets. However, the straight line method does not accurately reflect the difference in usage of an asset and may not be the most appropriate value calculation method for some depreciable assets. Carrying ValueCarrying value is the book value of assets in a company’s balance sheet, computed as the original cost less accumulated depreciation/impairments.

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This means that assets may appear to have an increased intrinsic value, even if this is not realistically the case. As such, businesses can take advantage of an upfront tax deduction by accelerating the depreciation of assets on their tax returns. In using the declining balance method, a company reports larger depreciation expenses during the earlier years of an asset’s useful life. To calculate 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. For example, due to rapid technological advancements, a straight line depreciation method may not be suitable for an asset such as a computer.

Subtract the estimated salvage value of the asset from the amount at which it is recorded on the books. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy. Straight line basis is popular because it is easy to calculate and understand, although it also has several drawbacks.

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From this case, the company will recognize a depreciation expense of Rp8 [(Rp100-Rp20) / 10] every year. The company reported a net asset value of Rp92 (Rp100-Rp8) in its balance sheet and a depreciation expense of Rp8 in the income statement at the end of the first year. The high-low method is a simplified version of the double-declining balance method. This is another accelerated depreciation method, and it is most appropriate when an asset will be used intensely for several years and then experience a decrease in use . The cost of an asset is the original purchase price of the asset. The salvage value is the market value of an asset at the end of its useful existence.

• Divide this number by the total number of years you expect the product to benefit your organization (the asset’s useful life).
• One of the most obvious pitfalls of using this method is that the useful life calculation is based on guesswork.
• The straight line method of depreciation is also useful for taxes and write-offs.
• With straight-line depreciation, you can reduce the value of a tangible asset.
• We’re here to take the guesswork out of running your own business—for good.
• However, the straight line method does not accurately reflect the difference in usage of an asset and may not be the most appropriate value calculation method for some depreciable assets.

The amortization of intangibles is the process of expensing the cost of an intangible asset over the projected life of the asset. Daniel Liberto is a journalist with over 10 years of experience working with publications such as the Financial Times, The Independent, and Investors Chronicle. He received his masters in journalism from the London College of Communication. Daniel is an expert in corporate finance and equity investing as well as podcast and video production.

Straight Line Depreciation Video

If it can later be resold, the asset’s salvage value is first subtracted from its cost to determine the depreciable cost – the cost to use for depreciation purposes. Each of those $1,600 charges would be balanced against a contra account under property, plant, and equipment on the balance sheet. This is known as accumulated depreciation, which effectively reduces the carrying value of the asset.

• Your bookkeeping team imports bank statements, categorizes transactions, and prepares financial statements every month.
• The most important difference between this formula and other common depreciation formulas is the denominator.
• It is the simplest method because it equally distributes the depreciation expense over the life of the asset.
• The straight-line depreciation method is a type of tax depreciation that an asset owner can elect to deduct the cost of the asset over the property’s useful life evenly.
• The IRS began to use what’s called the Accelerated Cost System of depreciation in 1986.
• It does not have to be claimed but will be counted regardless when figuring out taxes on the sale of the house.
• See how to find straight-line depreciation expense and rate using a straight-line depreciation example.

GAAP is a collection of accounting standards that set rules for how financial statements are prepared. It’s based on long-standing conventions, objectives and concepts addressing recognition, presentation, disclosure, and measurement of information. You would move $5,000 from the cash and cash equivalents line of the balance sheet to the property, plant, and equipment line of the balance sheet. According to straight-line depreciation, this is how much depreciation you have to subtract from the value of an asset each year to know its book value. Book value refers to the total value of an asset, taking into account how much it’s depreciated up to the current point in time. As buildings, tools and equipment wear out over time, they depreciate in value. Being able to calculate depreciation is crucial for writing off the cost of expensive purchases, and for doing your taxes properly.