This method is quite easy and could be applied to most types of fixed assets, and intangible fixed assets.
The straight-line depreciation method considers assets are used and provide the benefit equally to an entity over its useful life so that the depreciation charge is equally annually.
For example, the office building is naturally used by entity consistently and equally every month and year.
Therefore, the fittest depreciation method to apply for this kind of asset is the straight-line method. And if the cost of the building is 500,000 USD with useful life 50 years.
Then the depreciation expenses that should be charged to the build are 10k annually and equally.
This method is not applicable to the assets that the ways how it is used or performed are different from time to time.
For example, the production machine that is high performing in the first few years and then the performance is slow eventually.
The following is the formula and example that could help to illustrate the above definition,
The formula for the straight-line depreciation method is quite straightforward and very easy to calculate:
Depreciation expenses: (Book value – residual value) X depreciation rate:
- Book value of fixed assets is the original cost of fixed assets including another necessary cost before depreciation.
- The depreciation rate is the rate that fixed assets should be charged based on the year estimate. For example, if the assets using for four years, then the rate will be 25%, and if the assets use for five years the rate will be 20%.
- Residual value is the value of fixed assets at the end of its useful life. For example, the residual value of the computer, based on estimate would be 200$ at the year’s fours.
How to calculate the depreciation expenses?
Calculate the depreciation expenses by using the straight-line method is really really simple and quite straight forwards. This is one of the main reasons why this method is selected by most of the accountant.
First, all we need to do is to find book value or the initial capitalization costs of assets.
Those costs include:
- Its purchase price of fixed assets
- Import duties of assets and non-refundable purchase taxes. Discount and rebate should not take into account.
- Costs to bringing the asset to the location and condition and these costs should also be capitalized.
- And dismantling costs
Second, once the book value or initial capitalization costs of assets are identified, we need to identify the salvages value or the scrap value of assets at the end of the assets’ useful life.
This is very important because we need to calculate depreciable values or amounts.
Third, after measuring the capitalization costs of assets, next, we need to identify the useful life of assets. This will help us to calculate the annual depreciation rate.
And to calculate the annual depreciation rate, we just need to divide one with the number of useful life. For example, 1/5 years, then we get 20%.
Finally, we got all the items we need: Book value salvages value, depreciation rate. All we need to do is to minus book value with salvages and then multiply with depreciation rate.
We then get the first-year depreciation expenses. These expenses are charged equally over assets’ useful life.
The double entry for depreciation expenses is quite easy.
Debit depreciation expenses ( in Income Statement)
Credit accumulated depreciation expenses ( balance sheet)
- Depreciation expenses are a type of operating expense, but sometimes we also charge to cost of goods sold or the cost of products if those fixed assets involve with the production. Whatever it is, we can debit either to operating expenses or the cost of goods sold in income statements.
- We credit to the accumulated depreciation because we want to reduce the fixed assets from its book value to get its net book value.
Here is the example of deprecation expenses charged based on straight-line depreciation method:
For example, the company just purchased a car for admin staff use cost 55,000 USD. The car is estimated to be used for five years and the residual of the car at the year fifth would be 5,000 USD.
What is the depreciation expense of the car if we use the straight-line depreciation method?
- Book value of the car is 55,000 USD
- The depreciation rate is 20% (100%/5 years)
- Residual value 5,000 USD.
- First Year = (55,000 – 5,000) X 20% = 10,000 USD
- Second Year = (55,000 – 5,000) X 20% = 10,000 USD
- Third Year = (55,000 – 5,000) X 20% = 10,000 USD
- Fours Year = (55,000 – 5,000) X 20% = 10,000 USD
- Fifth Year = (55,000 – 5,000) X 20% = 10,000 USD
Debit depreciation expense = 10,000 USD
Credit accumulate depreciation expense = 10,000 USD
This entry will be the same for five years and at the end of fifth year asset net book value will remain only USD 5,000. This asset will not be depreciate but the company still use it as normal or make disposal.