Straight-line depreciation is a method of calculating the depreciation of an asset over a specific period of time. It is called “straight-line” because the rate of depreciation stays constant over the useful life of the asset.
This method is considered to be the most easiest to understand, as it involves dividing the cost of the asset by the number of years it is expected to be used.
To calculate straight-line depreciation, the following formula is used:
Depreciation Expense = (Cost of Asset – Salvage Value) / Useful Life of Asset
The cost of the asset is the original purchase price of the asset, including any taxes, transportation or fees. The salvage value is the estimated value of the asset at the end of its useful life, also known as its “residual value.” The useful life of the asset is the estimated number of years the asset will be used before it gets outdated to be of use.
For 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 would be calculated as follows:
Depreciation Expense = ($50,000 – $10,000) / 10 years = $4,000 per year
Under the straight-line method, the same amount of depreciation expense is recorded each year for the useful life of the asset. In this example, the company would record a depreciation expense of $4,000 per year for 10 years until the machine is fully depreciated.
Accumulated depreciation is the total amount of depreciation that has been recorded on an asset over its useful life. It is a total amount of depreciation charged for an asset over the period.
The purpose of accumulated depreciation is to record the decrease in value of an asset due to wear and tear, obsolescence, or other factors.
To calculate accumulated depreciation, the following formula is used:
Accumulated Depreciation = Opening balance of Accumulated Depreciation + Depreciation Expense for the Period
The opening balance of accumulated depreciation is the accumulated depreciation recorded at the beginning of the accounting period, while the depreciation expense for the period is the amount of depreciation recorded during the current accounting period.
For example, if a company recorded a depreciation expense of $10,000 in the first year of using a machine, the accumulated depreciation would be calculated as follows:
Accumulated Depreciation = $0 (beginning accumulated depreciation) + $4,000 (depreciation expense for the period) = $4,000
If the company recorded a depreciation expense of $4,000 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 process continues until the asset is fully depreciated, at which point the accumulated depreciation will equal the cost of the asset minus the salvage value.
In the example above, the accumulated depreciation would equal $50,000 (cost of the asset) – $10,000 (salvage value) = $40,000 when the asset is fully depreciated.
There are several factors to consider when choosing between straight-line depreciation and other methods of depreciation. One important factor is the pattern of use of the asset.
If an asset is expected to be used more heavily in the early years of its life and then see a decrease in use over time, a method like reducing balance depreciation may be more appropriate.
On the other hand, if an asset is expected to be used uniform over the useful life then it should be depreciated on straight line.