How to Calculate Straight Line Depreciation
by Mary Girsch-Bock | Published on May 18, 2022
Business owners use straight line depreciation to write off the expense of a fixed asset. The straight line method of depreciation gradually reduces the value of fixed or tangible assets by a set amount over a specific period of time. Only tangible assets, or assets you can touch, can be depreciated, with intangible assets amortized instead.
Straight line depreciation is considered a fixed cost that will appear on your adjusted trial balance, and it’s always added back into your operating cash flow balance since depreciation is not an operating cash expense, nor does it directly affect working capital.
Overview: What is straight line depreciation?
Straight line depreciation is the easiest depreciation method. Ideal for those just becoming familiar with accounting basics such as the accounting cycle, straight line depreciation is the most frequent depreciation method used by small businesses.
Why should your small business calculate straight line depreciation?
There are a lot of reasons businesses choose to use the straight line depreciation method. Straight line depreciation is by far the easiest method for your bookkeeper or accounting staff to calculate, and straight line depreciation expenses remain consistent throughout the useful life of the asset, making it easy to include the expense in your company budget.
Here are some reasons your small business should use straight line depreciation.
1. Easiest to calculate
The straight line depreciation method requires only that you determine the useful life of the asset, estimate salvage value, and calculate annual or even monthly depreciation expense. By far the easiest depreciation method to calculate, the straight line depreciation formula is:
(Asset cost - salvage value) ÷ useful life = annual depreciation
Because the depreciation expense remains the same for the entire useful life of the asset, your depreciation expense will remain consistent as well, making it much easier to calculate profit margin or create accurate financial projections.
3. Fewer errors
Straight line depreciation is the easiest depreciation method to calculate. As a result, the calculation is more likely to be accurate. While it can be useful to use double declining or other depreciation methods, those methods also present more complex formulas, which can result in errors, particularly for those new to depreciation.
How to calculate straight line depreciation
Calculating straight line depreciation is a five-step process, with a sixth step added if you’re expensing depreciation monthly. Let’s use the following situation as an example.
Sara runs a small nonprofit that recently purchased a copier for the office. The cost of the copier was $7,500. It cost $150 to ship the copier, and the taxes were $600, making the final cost of the copier $8,250.
Step 1: Calculate the cost of the asset
The first step in calculating straight line depreciation is calculating the cost of the asset. The final cost used in the depreciation calculation should include the base price of the asset along with any associated sales tax and delivery charges. As you can see from the sample transaction above, the total cost of the copier Sara purchased is:
$7,500 + $150 + $600 = $8,250
Tips for calculating cost:
When calculating the cost of an asset, be sure to do the following:
- Include all related costs: For instance, if you’re calculating the cost of installing a fence, be sure to include material costs and labor.
- Include any tax and delivery costs when calculating depreciation cost: The final cost of any asset should always include add-on costs such as taxes, handling, and delivery. Be sure to include those totals when calculating your asset cost.
Step 2: Calculate and subtract salvage value from asset cost
Straight line depreciation requires that you assign a salvage value to your asset. Salvage value is what you expect the asset to be worth after its useful life. For instance, let’s say Sara expects her copier to be worth $1,500 at the end of its useful life. If that’s the case, the calculation would be:
$8,250 - $1,500 = $6,750
Tips for estimating salvage value:
Estimating the salvage value of an asset is an inexact science. If you don’t expect the asset to be worth much at the end of its useful life, be sure to figure that into the calculation.
- Use common sense: If you purchase a 2020 vehicle for your business for $25,000, the salvage value of the vehicle after five years would probably be around $6,000.
- Be conservative with your estimate: It’s never helpful to overestimate the salvage value of your asset, as that will reduce the amount of depreciation expense you can take during its useful life.
Step 3: Determine the useful life of the asset
Before you can calculate depreciation of any kind, you must first determine the useful life of the asset you wish to depreciate. Here are some common assets and their useful lives.
|Asset Type||Useful Life|
|Tractors, manufacturing tools, and livestock||3 years|
|Vehicles including cars, trucks, and buses||5 years|
|Office machines, including copiers and fax machines||5 years|
|Furniture and fixtures||7 years|
For a complete list of assets and their useful lives, be sure to check out IRS Publication 946: How to Depreciate Property.
Tips for determining useful life:
The easiest way to determine the useful life of an asset is to refer to the IRS tables, which are found in Publication 946, referenced above.
- Estimate the useful life: You know your business better than anyone. If you think the vehicle you purchased will last fewer than five years, you may want to use another depreciation method, such as double declining depreciation.
- Refer to the IRS for confirmation: If you’re unsure about how long the useful life of an asset is, be sure to refer to the IRS tables for guidance and confirmation.
Step 4: Divide 1 by the number of years of useful life to determine annual depreciation rate
According to the above table, Sara’s copier’s useful life is five years. In order to calculate the annual depreciation rate, Sara would do the following calculation:
1 ÷ 5 = 0.20
This means Sara will depreciate her copier at a rate of 20% per year.
Tips for determining depreciation rate:
Because Sara’s copier’s useful life is five years, she would divide 1 into 5 in order to determine its annual depreciation rate.
- Always use years: Always use the number of years of useful life, not the value, when determining your annual depreciation rate.
- Always start your calculation with 1: Your calculation will always start with 1. If the copier had a useful life of 10 years, the calculation would be 1 ÷ 10 = 0.10.
Step 5: Multiply depreciation rate by asset cost
Your next step is multiplying the depreciation rate by the asset cost, minus the salvage value. Remember that Sara’s copier had a cost of $8,250 and a salvage value of $1,500 with an annual depreciation rate of 20%. Sara’s calculation would be:
20% x ($8,250 - $1,500) = $1,350
The annual depreciation expense for Sara’s copier would be $1,350.
Tips for determining annual depreciation expense:
There are a few things to remember when calculating annual depreciation:
- Be sure to include the cost minus the salvage value: When calculating your annual depreciation expense, be sure you use the cost minus the salvage value, which is required when calculating straight line depreciation.
- Decide whether you want to expense depreciation annually: While some businesses only post depreciation expenses annually, if you want to record depreciation monthly, see step 6.
Step 6: Divide annual depreciation by 12 to calculate monthly depreciation
The final step in calculating depreciation is calculating your monthly depreciation expense. That calculation is:
$1,350 ÷ 12 = $112.50
That means Sara’s monthly depreciation expense for the copier would be $112.50.
Tips for calculating monthly depreciation expense:
Here are some tips for calculating depreciation expense:
- Divide your annual total by 12 to get your monthly depreciation expense: While many businesses record depreciation expenses annually, you can take your calculation one step further by dividing your annual expense by 12 to obtain your monthly depreciation expense.
- Make it a recurring journal entry: Since your monthly depreciation expense will remain the same throughout the useful life of the asset, make your journal entry recurring so your depreciation accounts will always be up to date.
Recording depreciation affects both your income statement and your balance sheet. To record the purchase of the copier and the monthly depreciation expense, you’ll need to make the following journal entries.
|3/31/2020||Fixed Assets -- Copier||$8,250|
|To record the purchase of the copier|
|Accumulated Depreciation -- Copier||$112.50|
|To record monthly depreciation|
When you purchase the asset, you’ll post that transaction to your asset account and your cash account, creating a contra account in order to keep track of your accumulated depreciation. You can then record your depreciation expense to the general ledger while crediting the accumulated depreciation contra-account for the monthly depreciation expense total.
Straight line depreciation vs. declining balance depreciation: What's the difference?
The declining balance method calculates more depreciation expense initially, and uses a percentage of the asset's current book value, as opposed to its initial cost. So, the amount of depreciation declines over time, and continues until the salvage value is reached.
For example, let's say that you buy new computers for your business at an initial cost of $12,000, and you depreciate their value at 25% per year. If we estimate the salvage value at $3,000, this is a total depreciable cost of $10,000.
|Year||Book value||Depreciation||Total Depreciation|
In the last line of the chart, notice that 25% of $3,797 is $949, not the $797 that's listed. However, the total depreciation allowed is equal to the initial cost minus the salvage value, which is $9,000. At the point where this amount is reached, no further depreciation is allowed.
Benefits of each method
There are good reasons for using both of these methods, and the right one depends on the asset type in question. The straight-line depreciation method is the easiest to use, so it makes for simplified accounting calculations.
On the other hand, the declining balance method often provides a more accurate accounting of an asset's value. For instance, if you buy a new computer or smartphones for your employees, these types of assets naturally lose more value early in their life than they do later on.
Other assets lose their value in a steady manner (furniture or real estate are good examples), so it makes more sense to use straight-line depreciation in these cases.
In a nutshell, the depreciation method used depends on the nature of the assets in question, as well as the company's preference.
Below, we’ve provided you with some straight line depreciation examples.
1. Depreciating a tractor
Jim purchases a tractor for his ranch. The final cost of the tractor, including tax and delivery, is $25,000, and the expected salvage value is $6,000. According to the table above, Jim can depreciate the tractor over a three-year period.
Here is the straight line depreciation calculation for Jim’s tractor:
($25,000 - $6,000) ÷ 3 = $6,333.33
Jim’s annual depreciation expense is $6,333.33.
2. Depreciating furniture
Sally recently furnished her new office, purchasing desks, lamps, and tables. The total cost of the furniture and fixtures, including tax and delivery, was $9,000. Sally estimates the furniture will be worth around $1,500 at the end of its useful life, which, according to the chart above, is seven years.
Here’s the calculation for depreciating the furniture and fixtures for Sally’s office:
($9,000 - $1,500) ÷ 7 = $1,071.43
Sally decides she wants to record depreciation expense monthly, so she’ll need to do the following calculation as well:
$1,071.43 ÷ 12 = $89.29
Sally can now record straight line depreciation for her furniture each month for the next seven years.
Final thoughts on straight line depreciation
Even if you’re still struggling with understanding some accounting terms, fortunately, straight line depreciation is pretty straightforward. If you’re looking for accounting software to help you keep better track of your depreciation expenses, be sure to check out The Ascent’s accounting software reviews.
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