Straight-line Method of Depreciation
In straight-line depreciation method, cost of a fixed asset is reduced uniformly over the useful life of the asset. Since the depreciation expense charged to income statement in each period is the same, the carrying amount of the asset on balance sheet declines in a straight line.
Due to its simplicity, the straight-line method of depreciation is the most common depreciation method. Generally-accepted accounting principles (GAAP) require companies to depreciate its fixed assets using method that best reflects the pattern in which the assets are expected to generate economic benefits. While the straight-line method is appropriate in most cases, some fixed assets lose more value in initial years. In such situations accelerated depreciation methods are more appropriate.
Depreciation expense for a year under the straight-line method is calculated by dividing the depreciable amount (the difference between cost and salvage value) of the fixed asset by its useful life (in years).
|Straight-Line Depreciation Expense =||Depreciable Amount|
|Useful Life of the Asset|
Depreciable amount equals cost minus salvage value.
|Straight-Line Depreciation Expense =||Cost − Salvage Value|
|Useful Life of the Asset|
Cost is the amount at which the fixed asset is capitalized initially on balance sheet on its acquisition. Salvage value (also called residual value or scrap value) is the estimated value of the fixed asset at the end of its useful life. Since an amount equal to the salvage value can be recovered by selling the asset, only the difference between the cost and the salvage value is depreciated. Useful life of a fixed asset represents the number of accounting periods within which the asset is expected to generate economic benefits.
Annual depreciation rate under the straight-line equals 1 divided by the useful life.
Normally purchase of fixed assets does not coincide with the start of financial year. In such situations, some companies elect to charge the whole-year depreciation to income statement in the year of purchase and do not charge any depreciation expense in the year of disposal. Another method which is more appropriate is to charge proportionate depreciation for partial year which is calculated using the following formula:
|Straight-Line Depreciation Expense for Partial Year =||D ×||N|
D is the depreciation expense for a complete financial year.
N is the number of months during which the fixed asset was available for use.
Depreciation expense under the straight-line depreciation method is journalized as follows:
The same journal entry is posted at the end of each year of the useful life because the amount charged to expense is each full year is the same.
Straight-line depreciation can also be calculated using Microsoft Excel SLN function.
Example 1: Whole-Year Depreciation in Year of Purchase
On 1 Jan 20X1, Company A purchased a vehicle costing $20,000. The company expects the vehicle to be operational for 4 years at the end of which it can be sold for $5,000. Calculate depreciation expense for the year ended 31 Dec 20X1, 20X2, 20X3 and 20X4.
Depreciable amount of the vehicle is $15,000 ($20,000 cost minus $5,000 salvage value). Useful life is 4 years.
Depreciation expense for year ended 31 Dec 20X1 = $15,000 ÷ 4 = $3,750 per year.
Depreciation expense shall remain the same over the useful life. Hence, an amount of $3,750 shall be the depreciation expense for year ended 31 Dec 20X2, 20X3 and 20X4.
Example 2: Proportionate Depreciation
Assume the same data as in Example 1 above. Suppose Company A’s year end is 30th June instead of 31st December.
Under this scenario the vehicle is used only for 6 months in the financial year ended 30 June 20X1. Proportionate depreciation should be charged which is calculated by multiplying the full year straight line depreciation expense by a fraction representing the part of the accounting year during which the asset was used.
Depreciation expense for year ended 30 June 20X1 = [ ($20,000 − $5,000) ÷ 4 ] × 6/12 = $1,875
Full year depreciation shall be charged in financial year ended 30 June 20X2, 20X3 and 20X4. Partial depreciation shall be charged in the year of disposal i.e. financial year ended 30 June 20X5.
Income Statement and Balance Sheet Presentation
|Year ended 20X1-06-30||1,875||18,125|
|Year ended 20X2-06-30||3,750||14,375|
|Year ended 20X3-06-30||3,750||10,625|
|Year ended 20X4-06-30||3,750||6,875|
|Year ended 20X5-06-30||1,875||5,000|
Please note that the carrying amount of the asset will never fall below the salvage value because this is the amount which can be recovered even when the asset is no longer being used.