Straight-Line Method of Depreciation Definition & How It Works

Let’s say Standard Manufacturing owns a large machine that they purchased for $270,000. The machine has a useful life of four years and is depreciated using the double-declining balance method. As the asset was available for the whole period, the annual depreciation expense is not apportioned. The straight-line method of depreciation can be used to depreciate almost any type of tangible assets such as property, furniture, computers, and equipment. The straight-line basis is also an acceptable calculation method because it renders fewer errors over the life of the asset.

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• Therefore, Company A would depreciate the machine at the amount of $16,000 annually for 5 years.
• As buildings, tools and equipment wear out over time, they depreciate in value.
• Straight-line depreciation promotes clarity in your financial statements.
• First and foremost, you need to calculate the cost of the depreciable asset you are calculating straight-line depreciation for.
• Get $30 off a tax consultation with a licensed CPA or EA, and we’ll be sure to provide you with a robust, bespoke answer to whatever tax problems you may have.
• In accounting and finance, it’s a fundamental method for representing how tangible assets decrease in value over time.

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What Are Realistic Assumptions in the Straight-Line Method of Depreciation?

The double declining balance method calculates the annual depreciation rate by doubling the straight-line rate. For example, for an asset with a 10-year life, the straight-line rate would be 10% (100% / 10 years). It is easy to calculate and understand, making it a popular choice for businesses. Straight line depreciation is a widely-used method of allocating the cost of a fixed asset over its useful life.

• Note that the straight depreciation calculations should always start with 1.
• You can’t get a good grasp of the total value of your assets unless you figure out how much they’ve depreciated.
• On the balance sheet, depreciation affects both the assets and the accumulated depreciation accounts.
• This means that the value of the machine will decrease by $16,000 each year for the next 5 years until it reaches its estimated salvage value of $20,000.
• In this guide, you’ll learn when to use straight-line depreciation, its pros and cons and how to calculate it.
• This $1,000 is expensed to a contra account called accumulated depreciation until $500 is left on the books as the value of the equipment.
• Straight-line Depreciation is a method of allocating the cost of a depreciating asset evenly over its useful life.

Further reading: Understanding Depreciation: Impact on Income Statement and Balance Sheet

You can refer to the ATO’s effective life of depreciating assets, but in most cases, you can estimate the asset’s useful life – you’re the one who knows what your business needs. In Australia, your asset’s useful life is how long it’ll serve your business purposes. A high-end laptop may need to be replaced in two years by an IT consultant, but it could still hold value for personal use. Your asset cost includes anything you spent on getting it ready for use, including shipping or assembly charges.

Is there any other context you can provide?

In finance, a straight-line basis is a method for calculating depreciation and amortization. It is calculated by subtracting an asset’s salvage value from its current value and dividing the result by the number of years until it reaches its salvage value. This means taking the asset’s worth (the salvage value subtracted from the purchase price) and dividing it by its useful life.

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In this case, only 9 months of depreciation expense, or $5,400 ($7,200 x 9/12), is recorded on 31 December. In this approach, an equal amount of depreciation is assigned to each year in the asset’s service life. By a large margin, the most easily understandable and widely-used depreciation method is the straight-line method.

Formula

CFI is on a mission to enable anyone to be a great financial analyst and have a great career path. In order to help you advance your career, CFI has compiled many resources to assist you along the path. Get free guides, articles, tools and calculators to help you navigate the financial side of your business with ease. The car cost Bill $10,000 and has an estimated useful life of 5 years, at the end of which it will have a resale value of $4000.