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Straight-line Depreciation Method

By Yuriy Smirnov Ph.D.

Definition

The straight-line depreciation method implies that each full financial year charges the same amount of an asset’s initial cost. To find the annual depreciation expense, it is necessary to make certain assumptions about an asset’s useful life and salvage value.

Formula

If the straight-line depreciation method is applied, the annual depreciation expense depends on both the useful life and salvage value (also referred to as residual value) of an asset. Useful life determines the constant annual depreciation rate as follows:

Straight-line Depreciation Rate =  1  × 100%
Useful Life in Years

For example, if the useful life of an asset is estimated as 5 years, the annual depreciation rate will be 20%.

No Salvage Value

If an asset has no salvage value, the annual depreciation expense can be calculated as follows:

Straight-line Depreciation Expense =  Asset Cost
Useful Life in Years

When the useful life of an asset expires, its book value equals zero.

With Salvage Value

If an asset has salvage value, the formula above should be changed as follows:

Straight-line Depreciation Expense =  Asset Cost - Salvage Value
Useful Life in Years

When the useful life of an asset expires, its book value equals its salvage value.

Calculation Examples

Example 1

XYZ Logistic bought a new truck at the beginning of the financial year for $200,000. The accountant has estimated the useful life of the truck as 5 years and its salvage value as $50,000.

The annual depreciation expense will be $30,000.

Straight-line Depreciation Expense =  $200,000 - $50,000  = $30,000
5

The straight-line depreciation schedule is shown below.

 Straight-line depreciation calculation example

At the beginning of the year, the net book value of the truck equals its cost of $200,000. At the end of Year 1, the accumulated depreciation will amount to $30,000, and the net book value of the truck will be $170,000. At the end of Year 2, another depreciation expense of $30,000 will be applied, and the depreciation account will amount to $60,000. In turn, the net book value of the truck at the end of the year will be $140,000. The same calculation will be made for the other years.

Please note that the net book value of the truck at the end of Year 5 equals its salvage value of $50,000.

Example 2

Pixelart Entertainment has acquired a brand-new laptop for $4,000. The accountant estimated the useful life of the laptop as 2 years and assumed it would not have any salvage value. Moreover, the company prepares its financial statements on a quarterly basis.

The annual depreciation expense will amount to $2,000. The quarterly depreciation expense will be ¼ of the annual amount, namely $500. Thus, if the straight-line depreciation method is applied, the schedule is shown below.

Straight-line depreciation calculation example

Please note that at the end of Year 2 the net book value equals $0, and accumulated depreciation equals the laptop cost of $4,000.

Graph

Let’s refer to the data used in Example 1 to draw a graph of straight-line depreciation.

Graph of straight-line depreciation method

As we can see, the net book value of the truck is being reduced step-by-step by a depreciation expense of $30,000 charged at the end of each year. Finally, at the end of Year 5, the net book value reaches the salvage value of $50,000, and accumulated depreciation amounts to $150,000.

Journal Entries for Straight-line Depreciation

Let’s consider Example 1 data and make appropriate general journal entries. We know that XYZ Logistic prepares annual financial statements; thus, 5 entries should be made in the general journal. The debited account in the journal entry is Depreciation Expense, and the credited account is Accumulated Depreciation.

Journal entries under straight-line depreciation method

Please note that the Accumulated Depreciation contra asset account is credited instead of an Equipment asset account! It allows you to report an asset’s cost until the end of its useful life or until it is sold and simultaneously report the accumulated amount charged to depreciation expense.

Revision in Estimates

Estimates of useful life and salvage value can be revised. Let’s consider Example 1 and assume that at the end of Year 2 the accountant revised the useful life of the truck to 4 years and reduced its salvage value to $40,000.

The net book value of the truck at the end of Year 2 is $140,000, and the new salvage value is $40,000. This means that $100,000 ($140,000-$40,000) should be charged to depreciation expense in the next 2 years. Thus, the revised annual depreciation expense will amount to $50,000.

Straight-line Depreciation Expense =  $140,000 - $40,000  = $50,000
2

The revised straight-line depreciation schedule is as follows:

Revision of estimates under straight-line depreciation method

Advantages and Disadvantages

Advantages

  1. The straight-line depreciation method is approved for use by many accounting standards, including IFRS and GAAP, and is accepted by most tax authorities.
  2. This method is the simplest one to calculate annual depreciation expense.
  3. It is very useful for assets that have a pattern of economic benefits that can’t be precisely determined in advance.
  4. It can be applied to long-term assets that provide steady economic benefit during the useful life of the asset.

Disadvantages

  1. This method is not recommended for assets whose economic benefit declines during its useful life (e.g., machinery and computers).
  2. The straight-line depreciation method doesn’t reflect the intensity of an asset’s usage, which can differ significantly from one accounting period to another.