What is the Straight Line Depreciation Method?
The straight line depreciation method is used to calculate the annual depreciation expense of a fixed asset.
The straight line method is the simplest and most generally used method of calculating depreciation, and is given by the straight line method formula as follows:
Cost = Original cost of the fixed asset
Salvage (Residual) value = Estimated value of the fixed asset at the end of its useful life.
Useful life = Estimated life of the fixed asset in years.
The amount of the asset depreciated over its useful life is referred to as the depreciable cost and is equal to the cost less the salvage value of the asset.
Straight Line Method Example
If for example, a business has purchased equipment with a value of 10,000 and expects it to have a useful life of 3 years and an estimated salvage value of 1,000, then the straight line method calculation using the formula above would be as follows:
Depreciation = (Cost - Salvage Value) / Useful Life Depreciation = (10,000 - 1,000) / 3 years = 3,000 a year
The diagram below demonstrates how the asset is written down to its salvage value.
At the end of the 3 years the total depreciation expense in the income statement would be 9,000 (3 x 3,000), and the book value of the equipment would be 10,000 – 9,000 = 1,000, which is the salvage value.
Zero Salvage Value
If the salvage value is unknown or is likely to be a minimal amount, it is normal to assume it is zero, in which case the straight line depreciation formula is given by
Using the same information from the example above, the straight line method of depreciation would give depreciation of 10,000 / 3 = 3,333 per year, and after 3 years the equipment would have been written down to a book value of nil.
In this case, at the end of the 3 years the total depreciation expense in the income statement would be 10,000 (3 x 3,333), and the book value of the equipment would be 10,000 – 10,000 = Zero, which again is the expected salvage value.
Straight Line Depreciation Rate
Instead of dividing by the number of years in the depreciation calculation, the term (1 / Useful life) used in the formula above, can be converted to a depreciation rate.
The straight line depreciation rate is given by the following formula.
So using the example above, the cost was 10,000, salvage value 1,000 and useful life 3 years. The straight line rate is calculated as follows.
Depreciation rate = 1 / Useful life Depreciation rate = 1 / 3 = 33.33%
The depreciation expense is then given as (10,000 – 1,000) x 33.33% = 3,000 as before
Depreciation Calculation Methods
Straight line depreciation can be calculated using our straight-line method calculator, by using the straight-line depreciation tables (the answer is given by looking at the column for 3 years and the row for 10,000, the monthly amount shown is 278 per month), or alternatively using the Excel SLN function.
Under the straight line method, the depreciation is the same amount each year. If these amounts were plotted on a graph each year, the points would form a straight line, hence the name straight line depreciation. The method is alternatively referred to as the equal installment method, fixed installment method or original cost method of depreciation.
It is important to understand that although the depreciation expense affects the net income and therefore the equity of a business, it does not involve the movement of cash. No actual cash is put aside, the accumulated depreciation account simply reflects that funds will be needed in the future to replace the fixed assets which are reducing in value due to wear and tear.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.