Straight-line Depreciation Method: Definition, Formula, Example, More

2024-07-02

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. The company takes 50,000 as the depreciation expense every year for the next 5 years. Most often, the straight-line method is preferred when it is not possible to gauge a specific pattern in which the asset depreciates. It is used when the companies find it difficult to detect a pattern in which the asset is being used over time. Of the three methods discussed, we shall closely go through the Straight-line depreciation method in the following sections. Equal expenses are allocated to every unit and therefore, the calculation is done based on the output capability of the asset instead of the time in years.

Method to Get Straight Line Depreciation (Formula)

The IRS has specific rules regarding depreciation, and it is important to understand these rules in order to properly calculate and report depreciation on your tax return. The IRS allows businesses to use a variety of methods to calculate depreciation, including the Modified Accelerated Cost Recovery System (MACRS). In conclusion, depreciation is used in different sectors to allocate the cost of assets over their useful life. Manufacturing companies use the straight-line method of depreciation for their machinery and plant and machinery.

As a result these items are not reported among the assets appearing on the balance sheet. Fees earned from providing services and the amounts of merchandise sold. Under the accrual basis of accounting, revenues are recorded at the time of delivering the service or the merchandise, even if cash is not received at the time of delivery. You should consider our materials to be an introduction to selected accounting and bookkeeping topics (with complexities likely omitted).

For example, a company will have a Cash account in which every transaction involving cash is recorded. A company selling merchandise on credit will record these sales in a Sales account and in an Accounts Receivable account. To amplify this step, assume that a retailer had recorded depreciation on its fleet of delivery trucks up to December 31.

What is a Chart of Accounts? A How-To with Examples

For example, the production machine that is high performing in the first few years and then the performance is slow eventually. In this case, we should not use the straight-line method to depreciate the machine. We’ll record the final $700 in year eight to arrive at the total cost of $112,000.

How to calculate straight-line depreciation

Depreciating assets, including fixed assets, allows businesses to generate revenue while expensing a portion of the asset’s cost each year it has been used.
This article will explore the different types of depreciation and the key concepts in depreciation to help readers gain a better understanding of this important accounting concept.
Therefore, manufacturing companies use the straight-line method of depreciation to allocate the cost of these assets over their useful life.
The depreciation schedule is a record of all the assets owned by the company, the date of acquisition, the cost of the asset, the useful life of the asset, and the method of depreciation used.
Under the straight line method, the depreciation expense is evenly distributed over the asset’s life.

This $1,000 is expensed to a contra account called accumulated depreciation until $500 is left on the books as the value of the equipment. Moreover, the straight line basis does not factor in the accelerated loss of an asset’s value in the short-term, nor the likelihood that it will cost more to maintain as it gets older. The difference between declining balance (often called diminishing value depreciation) and straight-line depreciation is that diminishing value writes off a higher value in the first few years. Straight-line depreciation means you claim the same amount every year. Apply the straight-line depreciation formula (cost value x rate %) to calculate the depreciation amount you can claim each year.

You can learn more about impairment losses by reading the appropriate parts of an Intermediate Accounting textbook or visiting the Financial Accounting Standards Board’s website. This entry indicates that the account Depreciation Expense is being debited for $10,000 and the account Accumulated Depreciation is being credited for $10,000. Note how the book value of the machine at the end of year 5 is the same as the salvage value.

How to Calculate Depreciation Expense

Declining balance is an accelerated depreciation method that calculates the depreciation expense based on a fixed percentage of the remaining balance of the asset. Once depreciation has been calculated, the expense must be recorded as a journal entry. The journal entry would be used to record depreciation expenses for a specific accounting period and can be manually entered into a ledger.

However, the company realizes that the equipment will be useful only for 4 years instead of 5.
He has tested and review accounting software like QuickBooks and Xero, along with other small business tools.
With this cancellation, the copier’s annual depreciation expense would be $1320.
Using this amount, we can calculate the depreciation expense, accumulated depreciation, and carrying value of the asset for each year as follows.

It is important to note that once a depreciation method is chosen, it must be consistently applied throughout the asset’s useful life. Depreciation expense in the first and last accounting periods is usually lower than the middle years because assets are rarely acquired on the first day of an accounting year. All accounting years other than the first and the last one are charged depreciation expense in full using the straight line depreciation formula above. Notice that this graph shows the depreciation expense over an asset’s useful life and not the accounting years, which are rarely the same.

Likewise, if an asset is sold on the last day of the eleventh month of an accounting year, a time factor of 11/12 will be used. The Straight Line Method charges the depreciable cost (cost minus salvage value) of a long-term asset to the income statement equally over its useful straight line depreciation life. In this lesson, I explain the basics of straight line method and how you can use it to calculate the depreciation expense.

Depreciation Base of Assets

Then divide the resulting figure by the total number of years the asset is expected to be useful. Straight-line depreciation is the simplest method of calculating how much depreciation you should claim on your tax return for a capital asset worth over $1000. They are responsible for ensuring that the depreciation schedule is accurate and up-to-date. The depreciation schedule is a record of all the assets owned by the company, the date of acquisition, the cost of the asset, the useful life of the asset, and the method of depreciation used. The cash flow statement is a financial statement that shows the inflows and outflows of cash of a company over a specific period. Depreciation is added back to net income on the cash flow statement because it is a non-cash expense.

Keep in mind, though, you may need to explain your reasoning to the ATO. Your asset cost includes anything you spent on getting it ready for use, including shipping or assembly charges. The salvage value is the amount your asset will be worth when it’s no longer useful to your business. From sole traders who need simple solutions to small businesses looking to grow. So, the manufacturing company will depreciate the machinery with the amount of $10,000 annually for 5 years. This method helps to estimate the overall consumption pattern of the asset.

Declining balance depreciation involves applying a fixed percentage to the remaining book value of the asset each year. This method results in higher depreciation expense in the early years of an asset’s life and lower depreciation expense in later years. Understanding depreciation is crucial for businesses to make informed decisions about their assets. Depreciation can be a complex topic, as there are different types of depreciation and various methods of calculating it.