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Straight line method of depreciation

Straight line method is the simplest and the most popular method of depreciation. As the name of this method suggests, the depreciation expense of a fixed asset will remain same for every accounting period until the useful life of the fixed asset come to an end. In plain and simple language, if you have calculated $500 as the depreciation expense of a fixed asset for the current accounting period,  $500 will be considered as a depreciation expense in the each subsequent accounting period. There will be no change in the amount of depreciation expenses

Under straight line method of depreciation, depreciation expense for an accounting period is calculated by deducting the residual value from the cost of a fixed asset and the resultant net figure is divided by the useful life of that fixed asset which is pretty much simple

Consider the following formula for the straight line method




Lets say cost of a car is = $12000 Residual value = $2000 and its useful life is 10 years.

Here is how depreciation expense of the car is calculated:

Depreciation expense = (Cost – Residual value) / Useful life

By putting values in the formula

Depreciation expense = ($12000 – $2000) / 10 years
Depreciation expense = (10,000) / 10
Depreciation expense = 10,000/ 10
Depreciation expense = 1000 or 1000 dollars

Therefore,

Depreciation expense for the 1st year or accounting period = $1000

Depreciation expense for the 2nd year or accounting period = $1000

Depreciation expense for the 3rd year or accounting period = $1000

Depreciation expense for the 4th year or accounting period = $1000

Depreciation expense for the 5th year or accounting period = $1000

Depreciation expense for the 6th year or accounting period = $1000

Depreciation expense for the 7th year or accounting period = $1000

Depreciation expense for the 8th year or accounting period = $1000

Depreciation expense for the 9th year or accounting period = $1000

Depreciation expense for the 10th year or accounting period = $1000

Did you notice that depreciation expense i.e. $1000 remained same throughout the car’s useful life?


Example No. 1

XYZ Company purchased a machine on January 2012 at the total cost of $6000. The machine was estimated to have a useful life of 5 years and it will have a residual value of approximately $1000.

In straight line method, annual depreciation expense can be calculated by deducting residual value ($1000) from the total machine cost ($6000) and dividing the resultant figure by the useful life (5 years) of the car

Annual Depreciation expense = (Cost – Residual value) / Useful life
Annual depreciation expense = ($6000 – $1000) / 5 years
Annual depreciation expense = $5000 / 5 years
Annual depreciation expense = $1000

Therefore, depreciation expense for one year or annual depreciation expense is $1000

Following table demonstrates the depreciation expenses over entire useful of the machine


YearsCalculation of DepreciationDepreciation
Expenses
Accumulated
Depreciation*
Book value of the Asset*
Purchase

1st year

2nd year

3rd year

4th year

5th year




($6000 – $1000) / 5 years=$1000

($6000 – $1000) / 5 years=$1000

($6000 – $1000) / 5 years=$1000

($6000 – $1000) / 5 years=$1000

($6000 – $1000) / 5 years=$1000




$1000

$1000

$1000

$1000

$1000




$1000

$2000

$3000

$4000

$5000

$6000

$5000

$4000

$3000

$2000

$1000




*Accumulated depreciation = The total or accumulated amount of depreciation expenses at a point in time
*Book value = Cost the asset - Accumulated depreciation expenses
*Depreciable amount = Cost the asset - Residual value the asset

Example No.2

ABC Company purchased a building costing $12,000 on January 2012. The building useful life was estimated to be 10 years with residual value of $2000.

Required: Calculated amount of building depreciation expense using straight line method of depreciation for the year ended on 31 December, 2012?


Solution:

Formula of straight line method for calculating depreciation for an accounting period

Depreciation expense = (Cost – Residual value) / Useful life

Values that will be used in the calculation of depreciation

Building cost = $12000
Building Useful life = 10 years
Building residual value = $2000

By substituting values in the formula of straight line method

Depreciation expense = (12000 – 2000) / 10
Depreciation expense = 10,000 / 10
Depreciation expense = 1000

Hence, $1000 is the depreciation expense for the year ended on 31 December, 2012