Straight Line Method Of Calculating Depreciation And Amortization
Straight Line Method Of Calculating Depreciation And Amortization
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A 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 basis is calculated by dividing the difference between an asset’s cost and its expected salvage value by the number of years it is expected to be used.
- Straight line basis is a method of calculating depreciation and amortization, the process of expensing an asset over a longer period of time than when it was purchased.
- It is calculated by dividing the difference between an asset’s cost and its expected salvage value by the number of years it is expected to be used.
- Straight line basis is popular because it is easy to calculate and understand, although it also has several drawbacks.
- Alternatives often involve accelerating depreciation schedules.
In accounting, there are many different conventions that are designed to match sales and expenses to the period in which they are incurred. One convention that companies embrace is referred to as depreciation and amortization. Companies use depreciation for physical assets and amortization for intangible assets such as patents and software. Both conventions are used to expense an asset over a longer period of time, not just in the period it was purchased. In other words, companies can stretch the cost of assets over many different time frames, which lets them benefit from the asset without deducting the full cost from net income (NI).
Straight Line Method Of Calculating Depreciation And Amortization 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.
The straight-line depreciation formula for an asset is as follows:
The cost of the asset is the purchase price of the asset
Salvage value is the value of the asset at the end of its useful life
The useful life of the asset represents the number of periods/years in which the asset is expected to be used by the company
Additionally, the straight-line depreciation rate can be calculated as follows:
How to Calculate Straight Line Depreciation
The straight-line calculation steps are:
- Determine the cost of the asset.
- Subtract the estimated salvage value of the asset from the cost of the asset to get the total depreciable amount.
- Determine the useful life of the asset.
- Divide the sum of step (2) by the number arrived at in step (3) to get the annual depreciation amount.
Straight Line Method Of Calculating Depreciation And Amortization In addition to straight-line depreciation, there are also other methods of calculating the depreciation of an asset. Different methods of asset depreciation are used to more accurately reflect the depreciation and current value of an asset. A company may elect to use one depreciation method over another in order to gain tax or cash flow advantages.
1. Double-declining balance method
A double-declining balance method is a form of accelerated depreciation. 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 at 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.
2. Units of production method
The units of production method is based on an asset’s usage, activity, or units of goods produced. Therefore, depreciation would be higher in periods of high usage and lower in periods of low usage. This method can be used to depreciate assets where variation in usage is an important factor, such as cars based on miles driven or photocopiers on copies made.
You need three numbers to calculate straight-line depreciation for a fixed asset:
- The total purchase price of the asset (the cost of the asset including shipping, taxes, installation fees, etc.)
- Its scrap or salvage value of the asset—the price you think you can sell it for at the end of its useful life.
- The useful life of the asset—how many years you think it will last.
To calculate the straight-line depreciation rate for your asset, simply subtract the salvage value from the asset cost to get total depreciation, then divide that by useful life to get annual depreciation:
annual depreciation = (purchase price – salvage value) / useful life
According to straight-line depreciation, this is how much depreciation you have to subtract from the value of an asset each year to know its book value. Book value refers to the total value of an asset, taking into account how much it’s depreciated up to the current point in time.
A note on useful life: if you’re calculating the amount of depreciation for tax purposes, the useful life figure should come from the IRS, which has sorted most depreciable assets into one of seven “property classes.” (Property that depreciates over three, five, seven, 10, 15, 20, and 25 years, respectively.)
Let’s say your business buys a $2,000 MacBook that won’t be useful after five years, and its estimated salvage value—how much you think you can sell it for in five years—is $500. (Five years is the period over which the IRS says you have to depreciate computers.)
To determine straight-line depreciation for the MacBook, you have to calculate the following:
annual depreciation = ($2000 – $500) / 5 years
= $1,500 / 5 years
According to straight-line depreciation, your MacBook will depreciate $300 every year.
How is straight-line depreciation different from other methods?
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.
Compared to the other three methods, straight-line depreciation is by far the simplest.
Look at how much the MacBook in the example above depreciates every year, according to straight-line depreciation:
Year 1 depreciation: $300
Year 2 depreciation: $300
Year 3 depreciation: $300
Year 4 depreciation: $300
Year 5 depreciation: $300
Now let’s look at how much that same MacBook would depreciate under the double declining balance and the sum of years methods:
|Double declining method||Sum of years method|
|Year 1 depreciation: $800||Year 1 depreciation: $500|
|Year 2 depreciation: $480||Year 2 depreciation: $400|
|Year 3 depreciation: $220||Year 3 depreciation: $300|
|Year 4 depreciation: $0||Year 4 depreciation: $200|
|Year 5 depreciation: $0||Year 5 depreciation: $100|
Notice how both of these methods apply more depreciation at the start of the life of an asset than at the end of it. This can be useful and more accurate. (Most tangible assets like computers, vehicles and machinery tend to lose a majority of their value in the first few years of use.)
The unit-of-production method is similar to straight-line depreciation, except for one thing: instead of measuring depreciation using dollars, it measures it in units of production instead.
Units of production can be anything: the number of labels printed by a label printing machine, the number of miles traveled by a vehicle, or the number of kilowatt hours produced by a power plant.
To calculate depreciation using the unit-of-production method, you need two more pieces of information:
- The number of units an asset produced that year
- The total number of units you expect it to produce over its lifetime
Plug those figures into the following equation to get the total depreciation of your asset, measured in a number of units:
annual depreciation in # of units =
(purchase price – salvage value) x (# of units produced that year) / total # of units expected over lifetime
This method works best for equipment and tools that wear out with use—as they produce a certain number of units, travel a certain number of miles, produce a certain amount of electricity, etc.—rather than over time.
Straight-line depreciation is a common method of depreciation where the value of a fixed asset is reduced over its useful life.
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It’s used to reduce the carrying amount of a fixed asset over its useful life. With straight line depreciation, an asset’s cost is depreciated the same amount for each accounting period. You can then depreciate key assets on your tax income statement or business balance sheet.
This method was created to reflect the consumption pattern of the underlying asset. It is used when there’s no pattern to how you use the asset over time. Straight line depreciation is the easiest depreciation method to calculate. It also results in the fewest calculation errors. Thus, this calculation method is recommended.
Step 1: Calculate the total cost of the asset
First and foremost, you need to calculate the cost of the depreciable asset you are calculating straight-line depreciation for. After all, the purchase price or initial cost of the asset will determine how much is depreciated each year.
Let’s say that an office worker purchases a copier for $8000. However, it costs another $100 to ship the copier to the office. It also costs $500 in taxes. The copier costs, in total, $8600.
- $8000 + $100 + $500 = $8600
When you calculate the cost of an asset to depreciate, be sure to include any related costs. This can include material costs, labor, taxes, and more.
Step 2: Find and subtract any salvage value from the asset’s cost
With straight-line depreciation, you must assign a “salvage value” to the asset you are depreciating. The salvage value is how much you expect an asset to be worth after its “useful life”.
In the above example, say that the office worker expects the copier to be worth $2000 at the end of its useful life. The following calculation would look like this:
- $8600 – $2000 = $6600
The salvage value of an asset is somewhat inexact. Try to use common sense when determining the salvage value of an asset, and always be conservative. Don’t overestimate the salvage value of an asset since it will reduce the depreciation expense you can take.
Step 3: Calculate the asset’s useful life
You’ll next need to calculate the useful life of an asset if you want to depreciate it. Common assets and useful lives include:
- Office machines like copiers and fax machines – 5 years
- Fixtures and office furniture – 7 years
- Vehicles like cars and trucks – 5 years
- Livestock, manufacturing tools, and tractors – 3 years
Step 4: Determine the annual rate of depreciation
You can determine the annual depreciation rate of an asset with the following formula:
- 1 / Years of useful life
If the above copier has a useful life of five years according to the IRS, the equation looks like this:
- 1 / 5 = 0.20
In other words, the copier can be depreciated by 20% each year. Note that the straight depreciation calculations should always start with 1.
Step 5: Multiply your depreciation rate by the asset’s depreciable cost
The next step in the calculation is simple, but you have to subtract the salvage value. In our example, the copier cost $8600 at first. It had a salvage value of $2000. The annual depreciation rate is 20%.
The resulting calculation is:
- 20% x ($8600 – $2000) = $1320
With this cancellation, the copier’s annual depreciation expense would be $1320.
Step 6: Calculate monthly depreciation
Last but not least, you can calculate the monthly depreciation expense by taking the above number and dividing it by 12. You don’t have to stick with annual straight-line depreciation! For our example copier, the equation looks like this:
- $1320 / 12 = $110
In total, the copier’s monthly depreciation expense is $110.
Data collection methods
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 basis is calculated by dividing the difference between an asset’s cost and its expected salvage value by the number of years it is expected to be used.
The straight-line depreciation method makes it easy for you to calculate the expense of any fixed asset in your business. With straight-line depreciation, you can reduce the value of a tangible asset. Then you can benefit from that depreciation during tax season.
The data was collected through internet, research papers and online journals related to straight line method.
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- Things your company does well
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- Tangible assets such as intellectual property, capital, proprietary technologies, etc.
Once you’ve figured out your strengths, it’s time to turn that critical self-awareness on your weaknesses.
- Things your company lacks
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- Underserved markets for specific products
- Few competitors in your area
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The final element of a SWOT analysis is Threats – everything that poses a risk to either your company itself or its likelihood of success or growth.
- Emerging competitors
- Changing regulatory environment
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- Changing customer attitudes toward your company
Conclusion & Recommendations
Straight-line depreciation is the simplest method for calculating depreciation over time. Under this method, the same amount of depreciation is deducted from the value of an asset for every year of its useful life. The “straight line” is literal: If you were to graph the value of your asset over time, it would appear as a straight line from the initial cost to the point where it has reached salvage value.
To apply straight-line depreciation, you need to determine your cost basis for the asset (be sure to include costs like taxes, shipping and other fees, installation, etc.). You should also have a concrete number for the estimated useful life of the asset, as well as its salvage value, if any. Then accountants like the straight line method because it is easy to use, renders fewer errors over the life of the asset, and expenses the same amount every accounting period. Unlike more complex methodologies, such as double declining balance, straight line is simple and uses just three different variables to calculate the amount of depreciation each accounting period.
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.
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.
Straight line is the most straightforward and easiest method for calculating depreciation. It is most useful when an asset’s value decreases steadily over time at around the same rate.
While the purchase price of an asset is known, one must make assumptions regarding the salvage value and useful life. These numbers can be arrived at in several ways, but getting them wrong could be costly. Also, a straight line basis assumes that an asset’s value declines at a steady and unchanging rate. This may not be true for all assets, in which case a different method should be used.
Straight line amortization works just like its depreciation counterpart, but instead of having the value of a physical asset decline, amortization deals with intangible assets such as intellectual property or financial assets.
Depreciation expense is the recognition of the reduction of value of an asset over its useful life. Multiple methods of accounting for depreciation expense exist, but the straight-line method is the most commonly used. In this article, we covered the different methods used to calculate depreciation expense, and went through a specific example of a finance lease with straight-line depreciation expense.
- IRS Rev. Proc. 87-56 and 87-55 (shown in Publication 946 as tables, as currently updated)
- Fox, Stephen C., Income Tax in the USA, chapter 24, 2013 edition ISBN978-0-9851823-3-5, ASIN B00BCSNOGG
- Hoffman, William H. Jr., et al, South-Western Federal Taxation, chapter 8. 2013 edition 978-1-1331-8955-8, ASIN B00B6F3AWI.
- Pratt, James W.,; Kulsrud, William N., et al, Federal Taxation, chapter 9. 2013 edition ISBN978-1-133-49623-6.
- Kieso, Donald E; Weygandt, Jerry J.; and Warfield, Terry D.: Intermediate Accounting, Chapter 11. ISBN978-0-471-44896-9.
- Financial Accounting Standards Board (U.S.) Accounting Standards Codification 360-10-35. Available for free browsing access with registration.