Straight Line Depreciation: How to Calculate & Formula
Straight Line Depreciation: How to Calculate & Formula
Straight-line depreciation is the simplest way to compute depreciation expense. In computing straight-line depreciation, we consider three elements:
- Cost of the fixed asset: The cost of the asset is its purchase price net of discounts taken, plus sales taxes, shipping costs, insurance, and so on.
- Useful life: Useful life is the estimated length of time the fixed asset will remain in service.
- Salvage value: It’s the estimated resale or disposal value of the asset after its useful life.
The straight-line depreciation formula is:
| Straight line depreciation | = | Cost – Salvage value Useful life |
Under this method, annual depreciation remains the same throughout the fixed asset’s useful life. Most nonmanufacturing small businesses use straight-line depreciation because of its simplicity and reasonable allocation of costs across years.
Understanding the Straight Line Depreciation Method
The straight-line method accounts for depreciation uniformly through the asset’s useful life. This method is easy to implement for small businesses because of its simplicity. To understand how this method works better, let’s look at the graph below:
Graph Showing Straight-Line Depreciation Relationships
Depreciation expense under the straight-line method is uniform. Hence, it’s just a straight line in the graph and the reason the method got its name. However, pay attention to the asset’s book value. Over time, the book value decreases because of annual depreciation expense charges.
The decrease in the asset’s book value is also uniform because of equal depreciation charges per year. At the end of the useful life, the asset’s book value must be equal to the salvage value. That’s why the book value line touches the salvage value line.
Tip: Depreciation doesn’t forecast or measure the value of an asset. In our example above, we don’t necessarily expect the equipment to be worth $45,000 after one year. Depreciation is a way to allocate the $50,000 cost over multiple years, instead of deducting it all when the asset is purchased.
Straight Line Depreciation Example
Let’s assume that we acquired a fixed asset for $50,000 with an estimated salvage value of $5,000 at the end of its 10-year useful life.
Step 1: Compute the depreciable cost
The depreciable cost is the cost of the asset net of its salvage value. Since we expect to sell the asset at its estimated salvage value, we won’t include that amount in depreciation.
|
Depreciable cost
|
= Cost – Salvage value
|
|
= $50,000 – $5,000
|
|
|
Depreciable cost
|
= $45,000
|
Step 2: Compute the depreciation expense
By using the formula above, we can compute the annual depreciation expense by replacing the variables with our given amounts:
| Straight line depreciation | = | $45,000 10 years |
| = | $4,500/year |
Therefore, we allocate $4,500 of the cost to depreciation expense every year. The $4,500 will appear as both depreciation expense on our income statement and accumulated depreciation on our balance sheet, which reduces the cost of fixed assets.
Xero is the only software in our best small business accounting software guide with a dedicated fixed asset manager. We recommend choosing Xero if you need to keep track of multiple fixed assets.
Can QuickBooks Help Me Keep Track of Depreciation?
QuickBooks Enterprise has a fixed asset manager that computes your depreciation expense automatically. You can also store other information like asset number, purchase date, cost, purchase description, serial number, warranty expiration date, and others.
Bottom Line
The straight-lines method of depreciation provides small business owners with a simple formula for depreciation. In setting up your small business accounting system, knowing your depreciation methods can help you choose the right method that matches the pattern of usage of your fixed assets.
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