Calculating Straight-Line Depreciation
Small and large businesses widely use straight line depreciation for its simplicity, accuracy, and functionality, but other methods of calculating an asset’s depreciation value exist. Let’s break down how you can calculate straight-line depreciation step-by-step. We’ll use an office copier as an example asset for calculating the straight-line depreciation rate.
Company A purchases a machine for $100,000 with an estimated salvage value of $20,000 and a useful life of 5 years. Nearshoring, the process of relocating operations closer to home, has emerged as an explosive opportunity for American and Mexican companies to collaborate like never before. According to straight-line depreciation, your MacBook will depreciate $300 every year. This means that from the year of purchase, the truck will depreciate at $9,000 up to the 5th year. Cost of Asset is the initial purchase or construction cost of the asset as well as any related capital expenditure.
How does straight-line depreciation factor into my accounting?
When calculating a business’s contra account, bad debts, depletion and depreciation of the company’s assets are all crucial deductions to make. In order to write off the cost of expensive purchases and calculate your taxes accurately, knowing how to determine the depreciation of your company’s fixed asset is critical. From buildings to machines, equipment and tools, every business will have one or more fixed assets likely susceptible to depreciate or wear out gradually over time. For example, with constant use, a piece of company machinery bought in 2015 would have depreciated by 2019.
According to straight line depreciation, the company machinery will depreciate $500 every year. When you calculate the cost of an asset to depreciate, be sure to include any related costs. To calculate depreciation using a straight line basis, simply divide net price (purchase price less the salvage price) by the number of useful years of life the asset has. One method accountants use to determine this amount is the straight line basis method. Compared to the other three methods, straight line depreciation is by far the simplest.
The machine is estimated to have a useful life of 10 years and an estimated salvage value of $2,000. A company building, for example, is being used equally and consistently every day, month and throughout the year. Therefore, the depreciation value recorded on the company’s income statement will be the same every year of the building’s useful life. Note that the straight depreciation calculations should always start with 1. This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post.
Straight-line depreciation can be recorded as a debit to the depreciation expense account. It can also be a credit to your accumulated depreciation account. Accumulated depreciation is a contra asset account, so it is paired with and reduces the fixed asset account.
- You can always hire a professional accountant solution to handle this part of your business.
- The next step in the calculation is simple, but you have to subtract the salvage value.
- Things wear out at different rates, which calls for different methods of depreciation, like the double declining balance method, the sum of years method, or the unit-of-production method.
- Depending on how often they are used, different assets can wear out at different rates, and any method of calculating depreciation value may come in handy.
- To calculate the depreciation rate, divide the depreciation expense by the depreciable base.
You will find the depreciation expense used for each period until the value of the asset declines to its salvage value. The estimated useful life value used in our calculations are for illustration purposes. If you are calculating depreciation value for tax purposes, you should get the accurate, useful life figure from the Internal Revenue Agency (IRS).
How is straight-line depreciation different from other methods?
Once calculated, depreciation expense is recorded in the accounting records as a debit to the depreciation expense account and a credit to the accumulated depreciation account. Accumulated depreciation is a contra asset account, which means that it is paired with and reduces the fixed asset account. Accumulated depreciation is eliminated from the accounting records when a fixed asset is disposed of. It’s used to reduce the carrying amount of a fixed asset over its useful life.
But keep in mind this opens up the risk of overestimating the asset’s value. Note how the book value of the machine at the end of year 5 is the same as the salvage value. Over the useful life of an asset, the value of an asset should depreciate to its salvage value.
Understanding Straight Line Basis
The equipment has an expected life of 10 years and a salvage value of $500. With the straight line depreciation method, the value of an asset is reduced uniformly over each period until it reaches its salvage value. Straight line depreciation is the most commonly used and straightforward depreciation method for allocating the cost of a capital asset. It is calculated by simply dividing the cost of an asset, less its salvage value, by the useful life of the asset.
You can’t get a good grasp of the total value of your assets unless you figure out how much they’ve depreciated. This is especially important for businesses that own a lot of expensive, long-term assets that have long useful lives. The IRS has categorized depreciable assets into several property classes. These classes include properties that depreciate over three, five, ten, fifteen, twenty, and twenty-five years.
However, the simplicity of straight line basis is also one of its biggest drawbacks. One of the most obvious pitfalls of using this method is that the useful life calculation is based on guesswork. For example, there is always a risk that technological advancements could potentially render the asset obsolete earlier than expected. 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. Things wear out at different rates, which calls for different methods of depreciation, like the double declining balance method, the sum of years method, or the unit-of-production method. Depending on how often they are used, different assets can wear out at different rates, and any method of calculating depreciation value may come in handy.
It means that the asset will be depreciated faster than with the straight line method. The double-declining balance method results in higher depreciation expenses in the beginning of an asset’s life and lower depreciation expenses later. This method is used with assets that quickly lose value early in their useful life. A company may also choose to go with this method if it offers them tax or cash flow advantages.
Advantages and Disadvantages of Straight-Line Depreciation
The idea is that the value of the assets declines at a constant rate over its useful life. You would also credit a special kind of asset account called an accumulated depreciation account. These accounts have credit balance (when an asset has a credit balance, it’s like it has a ‘negative’ balance) meaning that they decrease the value of your assets as they increase. A fixed asset account is reduced when paired with accumulated depreciation as it is a contra asset account. It represents the depreciation expense evenly over the estimated full life of a fixed asset.
Still, the straight-line depreciation method is widely employed for its simplicity and functionality to determine the depreciation of assets being used over time without a particular pattern. Straight line basis is a method of calculating depreciation and amortization. Also known as straight line depreciation, it is the simplest way to work out the loss of value of an asset over time. Straight-line depreciation is a simple method for calculating how much a particular fixed asset depreciates (loses value) over time.
As a business owner, knowing how to calculate straight line depreciation of your company’s fixed assets is crucial to your business’s success. The other popular methods used in calculating depreciation value are; Sum of years method or unit of production method and double declining balance method. Using the straight line depreciation method in calculating a company’s depreciation of assets is highly recommended because it is the easiest method and results in the fewest calculation errors. Straight line depreciation is the default method used to recognize the carrying amount of a fixed asset evenly over its useful life. It is employed when there is no particular pattern to the manner in which an asset is to be utilized over time. Use of the straight-line method is highly recommended, since it is the easiest depreciation method to calculate, and so results in few calculation errors.