Straight Line Depreciation

Definition

The financial accounting term straight line depreciation refers to one of several methods of allocating the cost of an asset over its expected lifetime.  The straight line depreciation method is based on the assumption the asset will lose the same value each accounting period.

Calculation

Straight Line Depreciation = (Cost of Asset - Residual Value) / Life of Asset

Note:  The value found by the above formula would be an annual depreciation expense when the Life of Asset is expressed in years.

Explanation

The straight line depreciation method is perhaps the most commonly used approach to calculating depreciation expense.  With this method, an equal portion of the asset's cost is allocated across each time period.  The depreciable value of the asset is found by taking the cost of the item and subtracting from it the estimated residual value (or salvage value).  The depreciable value is then divided by the number of years, or accounting periods, the asset is expected to be used.

Depreciation is an accounting method of cost allocation.  It is used to allocate the cost of an asset over its useful life.  It's also referred to as a non-cash expense because the cash used to buy the asset left the company when it was purchased.  Depreciation allows the cost of a balance sheet item (an asset) to flow smoothly to the income statement (an expense) over its serviceable life.

Example

Company A purchases a backup generator for $200,000.  The estimated service life is projected to be 10 years.  The generator is anticipated to have a scrap value of $50,000 at the end of its serviceable life.

Company A would create an asset on its balance sheet for $200,000 in Year 0.  Each year, the company would depreciate the asset using the straight line method as follows:

= ($200,000 - $50,000) / 10 years
= $150,000 / 10 years, or $15,000 per year for 10 years.

In Year 1, Company A would show a depreciation expense of $15,000 on its income statement.  After 12 months, the asset's net book value would be:

$200,000 - $15,000 or $185,000

The depreciation schedule for the asset is shown in the table below:

  Depreciation Expense Accumulated Depreciation Book Value
Year 0     $200,000
Year 1 $15,000 $15,000 $185,000
Year 2 $15,000 $30,000 $170,000
Year 3 $15,000 $45,000 $155,000
Year 4 $15,000 $60,000 $140,000
Year 5 $15,000 $75,000 $125,000
Year 6 $15,000 $90,000 $110,000
Year 7 $15,000 $105,000 $95,000
Year 8 $15,000 $120,000 $80,000
Year 9 $15,000 $135,000 $65,000
Year 10 $15,000 $150,000 $50,000

Related Terms

asset, depreciation, income statementdeclining balanceunits of output, sum of the years digits, Modified Accelerated Cost Recovery Systemdepreciable base