Straight Line Method (Depreciation) - Explained
What is the Straight Line Basis?
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Table of ContentsWhat is the Straight Line Basis of Depreciation?How is the Straight Line Basis Depreciation Used?Example of Straight Line BasisAdvantages and DisadvantagesAcademic Research on Straight Line Basis
What is the Straight Line Basis of Depreciation?
Straight line basis, also called straight line depreciation, refers to a measure of determining depreciation and amortization on assets. It is one of the easiest ways to ascertain the decrease in an assets value over a given period of time. Straight line basis can be determined by subtracting the cost of the asset and the expected salvage value, and dividing the amount by the expected number of years the asset will be used.
How is the Straight Line Basis Depreciation Used?
Various accounting principles are used for verifying the expenses and sales for the time period in which they occurred. And, depreciation or amortization is one of those accounting principles used by organizations. While depreciation is used for measuring the loss of value of tangible assets, amortization is used for determining the loss in value of intangible assets like patents. These two accounting concepts determine the cost of an asset over a longer time period, rather than the year when it was bought. Hence, the firm can allocate the assets cost over several periods of time, thereby, helping it in receiving advantage from the asset without having the need to reduce its total cost from its net income. The main objective is to ascertain the amount that needs to be expensed. Accountants usually use straight line method for arriving at this amount. The company, that follows the straight line depreciation method, subtracts the salvage value of an asset from its original purchase price. Salvage value is the estimated amount at which the asset can be sold when it no longer serves any purpose. The final amount is divided by the estimated number of years for which the asset is considered to be useful. This is also referred to as the assets useful life in accounting terms. Straight Line Basis: (Purchase Price of asset - Salvage Value) / Expected useful life of asset
Key Points to Remember
The three data points are:
- Cost of the asset.
- Salvage value of the asset - eventual cost of the asset at the end of its life.
- Number of years the asset is expected to be in use.
Example of Straight Line Basis
Let's say, a company purchases a machinery of $10,500 with a useful life of 10 years, and a salvage or scrap value of $500. The accountant should deduct salvage value of the machinery from its original price, and divide the amount with it's useful life. Using the straight line basis method, the depreciation for the machinery will be $1,000 (($10,500 - $500) / 10). This states that instead of writing off the complete machinery cost in the existing time period, the company will have a depreciation expense of $1,000. The company will record $1000 as an expense in contra-account, which is also known as accumulated depreciation until the salvage value of $500 will be left in the accounting books.
Advantages and Disadvantages
Straight line method is easy to understand, and has less probability of having errors during the asset life. It also expenses equal amount of depreciation every year. As compared to double declining balance method of depreciation, straight line method considers only three factors, that is the original price of the asset, salvage value, and useful life of the asset for calculating depreciation for every year. However, the straight line method faces many shortcomings as well. This approach revolves more around estimates or random guesses. For instance, if there are fast technological improvements, the asset would tend to depreciate more quickly than the estimated time period. Also, this method excludes the loss in the value of an asset in the short-run. And the older it gets, the more maintenance costs the company would bear.
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