3. Straight Line Method
Straight line depreciation is the default method used to reduced uniformly
the cost of a fixed asset over the useful life of the asset. The method is
designed to reflect the consumption pattern of the underlying asset, and is
used when there is no particular pattern to the manner in which the asset
is to be used over time.
Due to its simplicity, straight line method of depreciation is the most
commonly used depreciation method, since it is the easiest depreciation
method to calculate compare with another method, and so results in few
calculation errors.
5. STEP 1
Enter the asset's purchase price. For example, if you
bought factory equipment for $1,000, then that's the
amount that you'll use as the purchase price.
6. Subtract the salvage value from the purchase price to find the
depreciable cost. The "scrap" or "salvage" value of the item
represents how much it will be worth once it's outlived its
usefulness. Subtract that number from the purchase price to get
the depreciable cost.
For example, if you bought the factory equipment mentioned
above for $1,000 and determined that it would be worth only
$200 at the end of its lifespan, then the depreciable cost is
$1,000 - $200 or $800.
STEP 2
7. STEP 3
Divide the depreciable cost by the asset's lifespan to get the
depreciation. The asset that you purchased has an expected
lifespan just like anything else (your personal computer, for
example, is something that you probably don't expect to use for
more than a few years). You'll need to know how many years you can
expect to get any use out of your new asset and then divide the
depreciable cost by that number.
For example, if the depreciable value of the asset is $800 and you
expect it to last 5 years, then the depreciation is $800 / 5 = $160.
That's the amount of depreciation for the asset that you'll enter in
your accounting books every year.
8. Example of calculation
On 1 Jan 2011, Company A purchased the Procrastinator
Deluxe machine that costing $60,000. The company
expects the vehicle to be operational for 5 years at the
end of which it can be sold for $10,000. Calculate
depreciation expense for the year ended 31 Dec 2011,
2012, 2013, 2014 and 2015.
9. Solution:
Method 1
Step 1 - Purchase cost of $60,000
Step 2 - Purchase cost of $60,000 – estimated salvage value of
$10,000 = Depreciable asset cost of $50,000
Step 3 - Depreciation expense for year ended 31 Dec 2011 =
$50,000 ÷ 5 = $10,000 per year.
Depreciation expense shall remain the same over the useful life.
Hence, an amount of $10,000 shall be the depreciation expense for
year ended 31 Dec 2012, 2013, 2014 and 2015
10. Solution:
Method 2
Step 1 - Purchase cost of $60,000
Step 2 - Purchase cost of $60,000 – estimated salvage value of
$10,000 = Depreciable asset cost of $50,000
Step 3 - 1 / 5-year useful life = 20% depreciation rate per year
Step 4 - 20% depreciation rate x $50,000 depreciable asset cost
= $10,000 annual depreciation
11. 1. Straight-Line Depreciation
The asset's initial cost
The salvage value (It's estimated value at the end of its useful
life)
The useful lifespan, in years
Formula for Annual Depreciation Rate:
Compare of other depreciation
method
12. 2. Declining Balance Depreciation
The declining balance method calculates more depreciation expense initially, and
uses a percentage of the asset's current book value, as opposed to its initial cost.
The amount of depreciation declines over time, and continues until the salvage
value is reached.
For example, buy new computers initial cost of $12,000, and depreciate their value
at 25% per year. Estimate the salvage value at $3,000, total depreciable cost is
$9,000.
13. Difference between straight line
method and reducing balance method
Straight line method Reducing balance method
Easier to use Hard to use
Useful when the company does
not intend to sell the asset
Provide more accurate
accounting an asset’s value
Expenses the same amount each
year
Changes depreciation
percentage of asset’s book
value
