How is Straight Line Depreciation Calculated? [Step by Step with Examples]
What is the Straight Line depreciation Method?
Depreciation refers to the gradual decrease in the value of an asset over time due to usage, wear and tear, or obsolescence.
In other words, depreciation is an accounting treatment used to spread the cost of a tangible asset over its useful life.
There are two main methods of calculating depreciation:
- Straight line method
- Reducing balance method
Straight line depreciation is one of the most commonly used methods of calculating depreciation, and it is often preferred because of its simplicity and ease of calculation.
It assumes that the asset loses an equal amount of value each year over its useful life, which is determined based on factors such as the asset’s expected usage, maintenance, and resale value.
Formula for Straight Line Depreciation
The formula for straight line depreciation is as follows:
[Cost of asset – Salvage value] / Useful life of asset in periods = Depreciation expense per period
Where:
- Cost of asset is the initial purchase price or the acquisition cost of the asset.
- Salvage value is the estimated amount that the asset will be worth at the end of its useful life.
- Useful life of asset in periods is the expected number of periods (such as years) that the asset will be used before it is discontinued or disposed of.
How to Calculate Straight Line Depreciation (Method with Example)
Calculating straight line depreciation is a reasonably simple process that involves following a few basic steps:
Step 1: Determine the cost of asset
The first step in calculating straight line depreciation is to determine the total cost of the asset.
This includes the purchase price of the asset, any delivery or installation fees, and any other costs associated with bringing the asset into use, such as setup costs.
Step 2: Determine the useful life of the asset
The second step is to determine the asset’s useful life, which is the estimated period of time over which the asset will provide value to the business.
This can be decided using factors such as the expected usage of the asset, its maintenance requirements, and its expected resale value.
Step 3: Determine the salvage value
The salvage value is the estimated value of the asset at the end of its useful life.
This is the amount that the business expects to receive when it sells or disposes of the asset – ie selling price or scrap value. This can be achieved by looking at current market values for similar assets.
Step 4: Use the formula to calculate the depreciation expense
The final step, to calculate the straight line depreciation expense, is to plug the numbers from Steps 1-3 into the Straight Line Depreciation formula (as above).
Example Calculation of Straight Line Method of Depreciation
To illustrate this process, let’s say that a company purchases an embroidery machine for £30,000. Delivery and one-off set up costs are a further £2,000.
The estimated useful life of the machine is 12 years, and the estimated salvage value at the end of its useful life is £2,000.
The depreciable cost of the machine is calculated as follows:
Step 1: Determine the cost of asset
£30,000 purchase price + £2,000 delivery and installation = £32,000
Step 2: Determine the useful life of the asset
Based on other machines that the company owns, the estimated useful life is 12 years.
Step 3: Determine the salvage value
Based on current market value for similar machines that are 12 years old, the estimated salvage value is £2,000.
Step 4: Use the formula to calculate the depreciation expense
(Cost of asset – Salvage value) / Useful life of asset in periods = Depreciation expense per period
[£32,000 – £2,000] / 12 years = £2,500 per year
Therefore, the company should record an annual depreciation expense of £2,500 for the machine using the straight line method, as per the table below:
Examples of Straight line Depreciation in the Real World
Straight line depreciation is commonly used by businesses of all sizes and across a diverse range of industries.
This method is particularly useful for assets that have a predictable useful life and a steady rate of decline in value over time, usually due to use or wear-and-tear.
Here are some examples of how straight line depreciation is applied in reality:
Buildings and real estate | Warehouses, factories and offices |
Vehicles and equipment | Delivery trucks, diggers, cranes, printing presses, manufacturing equipment |
Software and technology | computer software, servers, and hardware |
