Straight Line Depreciation

The simplest method of depreciating capital assets or fixed assets is known as straight line depreciation.  Before we discuss straight line depreciation, let’s briefly review why depreciation is used in accounting.  

Simply put, depreciation and deprecation expense is used in accounting in order to reflect the reduction in value of a company’s fixed asset or pool of fixed assets.  Fixed assets are assets valued at over $500 which have a useful life beyond a one year period; although some exceptions do apply.

Now that you know why fixed assets undergo the process of depreciation, let’s discuss straight line depreciation.  As mentioned earlier, straight line depreciation is the easiest method of depreciation.  Here is a simple example which will help you understand straight line depreciation.  

Assume for a moment, your business purchased a brand new computer valued at $5,000.  Also assume your accountant informs you that the computer has an estimated useful life of five (5) years.  Using straight line depreciation, what is the computer’s depreciation expense in each year of its useful life?   

Below shows the formula for straight line depreciation.  For this example, please disregard the term Salvage Value.  We will consider it later on as we further discuss straight line depreciation.

Straight Line Depreciation  =       Cost of the Fixed Asset – Salvage      
                                                Estimated Useful Life of the Fixed Asset

Using the assumptions above, here is how you arrive at depreciation expense using straight line depreciation.   

Straight Line Depreciation   =             $5,000  -  $0.00   
                                                       Useful Life of 5 Years

Straight Line Depreciation   =     $1,000 straight line deprecation expense per year.

As a result, straight line depreciation expense for the computer would appear on the income statement each year with a $1,000 account balance.  In addition, the balance sheet  would express the depreciation expense as an accumulated deprecation of $1,000 per annum. After the 5 year period, the accumulated deprecation on the balance sheet for this particular computer would have a balance of $5,000 (IE $1,000 per year over the computer’s useful life of 5 years = $5,000).

There is one more accounting term you need to familiarize yourself as it relates to straight line depreciation. The accounting term is known as salvage value.  Salvage Value of a fixed asset is the portion of its cost that is estimated to be recovered at the end of the asset’s useful life.  In other words, the salvage value is the estimated amount of money you should be able to sell the asset for at the end of its estimated useful life.

In the above computer example, the accountant estimated the computer would have no significant value after its five (5) year useful life.  This is certainly a realistic assumption.  How much would you pay for a five year old computer?  Most likely, very little.

So let’s use a new situation to tie salvage value in with straight line depreciation.  Assume you own a car rental business.  Also assume your company purchased a new automobile for $28,000 which is expected to have an estimated useful life, also referred to as service life, of five (5 years).  Your accountant suggests the automobile could be sold for $3,000 at the end of its 5 year service life.  Using the above information along with the straight line depreciation method of depreciation, what is the depreciation expense each year.
 
As mentioned earlier, straight line depreciation is found by using the following formula.

Straight Line Depreciation  =       Cost of the Fixed Asset – Salvage      
                                                Estimated Useful Life of the Fixed Asset

Using the assumptions above, here is how you arrive at straight line depreciation.   

Straight Line Depreciation    =          $28,000 - $3,000   
                                                     Useful Life of 5 years  

Straight Line Depreciation    =     $5,000 straight line deprecation expense per year.

Using straight line depreciation, the depreciation expense of the automobile would appear on the income statement each year having a $5,000 account balance.  In addition, the balance sheet would reflect the depreciation expense as accumulated deprecation of $5,000 per year. At the end of the useful life, the accumulated deprecation on the balance sheet for this particular automobile would be $25,000 (IE $5,000 per year over the 5 year useful life = $25,000). In addition, the automobile is expected to sell for $3,000 at the end of its 5 year useful life.

Straight line depreciation assigns an equal depreciation expense each year of the fixed assets’ useful life.  Below shows the depreciation expense of the automobile each year using straight line depreciation.

Year:        Depreciation Expense

Year 1                  $5,000
Year 2                  $5,000
Year 3                  $5,000
Year 4                  $5,000
Year 5                  $5,000
    

Using straight line depreciation, the income statement will assign $5,000 each year to reflect the Automobile’s depreciation expense.

The Balance Sheet will assign $5,000 per year to the automobile’s accumulated depreciation account.  Using straight line depreciation along with the example above, the accumulated depreciation account will appear on the balance sheet as follows.

Year:        Accumulated Depreciation Expense

Year 1                            $  5,000
Year 2                            $10,000
Year 3                            $15,000
Year 4                            $20,000
Year 5                            $25,000

To summarize, straight line depreciation is the simplest method for depreciating fixed assets.  Three pieces of information is required in order to determine straight line depreciation; namely, the cost of the fixed asset, the estimated useful life of the fixed asset and the salvage value of the fixed asset.  The straight line depreciation formula is as follows:

Straight Line Depreciation  =       Cost of the Fixed Asset – Salvage      
                                                Estimated Useful Life of the Fixed Asset

Related Articles:

Depreciation Expense
Accumulated Depreciation Expense
Fixed Assets
Balance Sheet
Income Statement