What is Straight-Line Depreciation?

Q:

What is straight-line depreciation?

A:

Straight-line depreciation is the most common method to depreciate assets in the United States. It is also the easiest method to learn and to utilize in accounting.

Useful Life

The straight-line method involves a constant rate of depreciation over a period of time. This period of time is the estimated useful life of a tangible fixed asset such as machinery or a building. Essentially, the useful life is the estimated amount of time the asset will provide a benefit to the company as determined by the company through their judgement. An asset’s useful life can be adjusted over time as circumstances or events cause a change in the useful life estimate.

Salvage Value

In order to calculate straight-line depreciation, you will also need to determine if the asset has a salvage value. The salvage value is the amount projected to be received for the asset when it is no longer productive. It is also known as scrap value, residual value, or disposal value.

How to Calculate Straight-Line Depreciation

There are two ways to calculate straight-line depreciation. Both methods will supply the same result as outlined below:

Method 1:

1) Determine the Depreciable Base:
Depreciable Base = Acquistion Cost of Asset – Salvage Value

2) Calculate the Depreciation Expense:
Depreciable Base ÷ Useful Life = Annual Depreciation Expense

Method 2:

1) Find the Straight-Line Rate: 
1 ÷ Useful Life

2) Determine the Depreciable Base:
Depreciable Base = Acquisition Cost of Asset – Salvage Value

3) Calculate the Depreciation Expense:
Depreciable Base x  Straight-Line Rate = Annual Depreciation Expense

Example of Straight-Line Depreciation

On January 1, XYZ Corporation obtained a piece of machinery for a total acquisition cost of $500,000. XYZ estimates the useful life will be 5 years and the salvage value will be $25,000.

We will calculate the annual straight-line depreciation using the two calculation methods shown above. Again, both methods produce the same results so pick the method that is easiest for you.

Method 1:

$500,000 acquisition cost – $25,000 salvage value = $475,000 Depreciable Expense

$475,000 Depreciable Expense ÷ 5  Years Useful Life = $95,000 Depreciation Expense

Method 2:

1 ÷ 5  Years Useful Life = 0.2 Straight-Line Rate

$500,000 acquisition cost – $25,000 salvage value = $475,000 Depreciable Expense

$475,000 Depreciable Expense x 0.2 Straight-Line Rate= $95,000 Depreciation Expense

Journal Entry – Ending of Year 1

You would complete the following journal entry at the end of the year for the depreciation.

Account NameDebitCredit
Depreciation Expense95,000
Accumulated Depreciation95,000

The below depreciation schedule shows how the depreciation, cumulative depreciation, and end of the year book value will look over the five years of the asset’s useful life:

YearDepreciation ExpenseAccumulated DepreciationBook Value at Year End
Acquisition Cost500,000
195,00095,000405,000
295,000190,000310,000
395,000285,000215,000
495,000380000120,000
595,00047500025,000 *
* Final book value is equal to salvage value

 

Partial-Period Depreciation

The above example was pretty straightforward because the tangible asset was acquired on January 1st. Realistically, a firm might acquire an asset at any point during the year. Let’s use October 1 as an example. In this case, a firm may use partial-period depreciation since using a full year of depreciation would not be accurate.

To figure out partial-period depreciation, we have to find out how many months are remaining in the year after the asset was acquired. If the asset was acquired on October 1, this would mean that three months remain in the year. Based on this, the depreciation for year one would be determine as follows. Again, assume a $500,000 purchase price, a $25,000 salvage value, and a 5 year useful life.

1) Determine the Yearly Depreciation Expense
$500,000 acquisition cost – $25,000 salvage value = $475,000 Depreciable Expense

$475,000 Depreciable Expense ÷ 5  Years Useful Life = $95,000 Yearly Depreciation Expense

2)Determine the Remaining Months

Since the assets was purchased on October 1st, there are three months remaining in the year. We then use the following calculation:

(3 remaining months ÷ 12 months) = .25

3) Calculate the Partial Year Depreciation for Year 1

$95,000 full year depreciation expense x .25 = $23,750

Note that the depreciation in year 2 will be the full $95,000 because the asset will be held for all 12 months.