The straight-line (SL) depreciation method is one of the easiest accounting methods of computing the depreciation expense of about any depreciable assets for a period. It spreads out evenly all cost associated with the purchase (initial cost) over useful life of the property. The simplicity of the straight-line depreciation method makes it understandable, reasonable, widely usable and acceptable. The SL deprecation accounting method is used commonly among different size and form of organizations especially smaller ones.
To find the depreciation expense for each period of an asset’s usage by applying the straight line depreciation method an entity needs to compute the following formula:
Depreciation expense = (Initial cost – Salvage value) / # of years used
Note that initial cost of an asset is not all the time equals to the purchase price alone. Depending on the type of property an entity might need to add such costs as freight in (if they paid for it) or subtract a discount (if they had any). In addition, some legal fees, cost to put such assets to use, or train its personal to operate some equipment may need to be added to arrive at the total initial cost of the purchase.
Salvage value is just an estimated worth of an asset at the end of its useful life. It is the amount that an entity plans to realize the property. If the firm does not expect to have any value of the asset then $0 (scrap value) should be subtracted from the initial cost.
For example, let’s assume that a company bought equipment for $20,000 and expects to use it for 4 years and then plans to realize that for $4,000 at the end of its service life. To find out what is depreciation expense for each period of the asset usage the firm needs to perform the following calculations.
Computation of depreciation for a period by using the straight line depreciation method
|Years||Initial cost||Depreciation expense||Depreciation base||Accumulated depreciation||Carrying value||Net book value|
|A||B||C*||D = B - C||E||F = B - E|
|1||$20,000||$4,000||$16,000||$4,000||(D1)||$16,000||$20,000 - $4,000|
|2||$20,000||$4,000||$16,000||$8,000||(D1 + D2)||$12,000||$16,000 - $4,000|
|3||$20,000||$4,000||$16,000||$12,000||(D1 + D2 + D3)||$8,000||$12,000 - $4,000|
|4||$20,000||$4,000||$16,000||$16,000||(D1 + D2 + D3 +D4)||$4,000||$8,000 - $4,000|
*Depreciation expense in each year = (Initial cost - Salvage value) / Useful life
$4,000 = ($20,000 - $4,000) / 4 years
As we can see the calculation is nice and smooth because the amount of depreciation expense spreads out evenly throughout the periods of the asset’s useful life.
Advantages of straight line depreciation method
- Simplest depreciation method to compute
- Can be applied to all long-term assets
- The same for each period of assets’ service life
- Widely acceptable and usable accounting method
Disadvantages of straight line depreciation method
- Does not reflect accurately the difference in usage of an asset from one period to the other
- Does not necessary match costs with revenues in different types of long-term assets
- Might not be appropriate for some depreciable assets due to rapidly developing technology, such as computers