A method by which the depreciation of an asset is calculated over a period is known as straight-line depreciation. The fact that the depreciation rate stays consistent over the useful life of an asset gives it the name of a Straight line.
It is the most painless method to calculate depreciation over time. It is highly recommended to use the straight-line depreciation method because of the ease of calculating it and results with few error calculations.
Calculating the straight-line depreciation is easy as it simply divides the asset cost by the years it is expected to be used.
The formula given below shows how to calculate the straight-line depreciation:
Depreciation Expense = (Cost of Asset – Salvage Value) / Useful Life of Asset
The original purchase price of an asset is the cost of an asset, along with any taxes, transportation, or fees. The salvage value is the estimated value of the asset at the end of the useful life of an asset, also known as its “Residual Value.” The estimated number of years the asset will be used before it becomes outdated to be of use.
Taking an example, if a company buys a machine for $50,000 with a useful life of 10 years and a salvage value of $10,000, the depreciation expense will be calculated as given below:
Depreciation Expense = ($50,000 – $10,000) / 10 years = $4,000 per year
With the straight-line depreciation method, the same depreciation expense is recorded yearly for the useful life of an asset.
Therefore, in the given example, the company will record the depreciation expense of $4000/year for the next 10 years until the machine is completely depreciated.
The total depreciation of an asset over its useful life is termed accumulated depreciation. It is the total amount of depreciation charged for an asset over time.
Accumulated depreciation is recorded to note the decrease in the asset’s value due to ablation, obsolescence, and other factors.
The given formula is used to calculate the accumulated depreciation:
Accumulated Depreciation = Opening balance of Accumulated depreciation + Depreciation Expense for the Period
The opening balance of accumulated depreciation is the accumulated depreciation documented at the start of an accounting period. The depreciation expense is the depreciation recorded in the current accounting period.
As an example, in the first year of using a machine, if a company records a depreciation expense of $10000, the accumulated depreciation will be calculated as follows:
Accumulated Depreciation = $0 (beginning accumulated depreciation) + $4,000 (depreciation expense for the period) = $4,000
If the depreciation expense of $4000 were recorded in the second year as well, the accumulated depreciation would be calculated as follows:
Accumulated Depreciation = $4,000 (opening balance of accumulated depreciation) + $4,000 (depreciation expense for the period) = $8,000
This goes on until the asset is completely depreciated when the point of accumulated depreciation will be equal to the asset’s cost minus the salvage cost.
In the above example, the accumulated depreciation would equal $50,000 (cost of the asset) – $10,000 (salvage value) = $40,000 when the asset is fully depreciated.
Bottom Line:
In conclusion, straight-line depreciation is a simple and widely used method for calculating the depreciation of an asset over its useful life. By using this method, companies can spread the cost of an asset over its useful life and accurately reflect it’s decreasing value in their financial statements.
Understanding straight-line depreciation and accumulated depreciation is essential for proper financial reporting and decision-making in managing assets.