Accounting, bookkeeping, calculating tax deductions, and maintaining balance sheets have to be the most boring tasks for every business owner!
Nobody wants to do it, which is why sometimes businesses prefer opting for the best online bookkeeping services to do these tasks for them.
However, if you’d rather do it yourself then this guide on how to calculate depreciation using the straight-line formula is for you.
Depreciation is the subsequent reduction in the monetary value of assets over a particular period.
It’s normal for your assets to decrease in value with time because of regular use. In fact, it’s perfectly normal.
Once you read our guide, you’ll be quite familiar with how to calculate straight-line depreciation.
Here are some of the major aspects related to straight-line depreciation that we will cover in this guide.
- Understanding Straight Line Depreciation
- The Calculation Of Depreciation Using Straight Line Method
- Example Of Straight Line Method Of Depreciation
- Why Choose Straight Line Depreciation?
- The Best Use Of The Straight Line Method
- The Conclusion
Understanding Straight Line Depreciation
Calculating depreciation is important for the time when you decide to sell or replace your assets.
Of course, you can’t sell a car you’ve owned for five years at the same price you bought it for – that’s why you need to calculate depreciation. To fulfill that purpose, people opt for the straight-line depreciation method.
The easiest method you can learn for calculating depreciation is the straight-line method. It’s best for businesses that only know the basics of accounting.
This simple method helps you in calculating depreciation for all your assets over time. It’s best suited for small businesses, individuals, or startups.
Where does the term “straight line” come from in the name?
Typically, a straight line means a decrease in value at a constant rate. Have a look at this representation:
That’s why the straight-line method has a “straight line” in the term. The graph represents a straight line, which indicates a constant reduction in price.
The Calculation Of Depreciation Using Straight Line Method
The calculation of depreciation helps you know the current market value of any asset that you own, should you decide to sell it.
Once we go over the basics of the straight-line depreciation formula, you’ll understand how easy it is to deploy it.
Before we get into the formula, let’s look at some details you’ll need to understand before going through with the actual calculation.
- You need the total cost you have paid for the asset which includes, buying price, shipping charges, taxes, duties, and installation charges (if there were any).
- A scrap or salvage value. It’s the value that you think you can sell it for in the current market. It can be determined using the selling price of a new piece for the same asset.
- The expected life of the asset that you think it can survive.
Okay, now that the basics of the formula are out of the way. Let’s get to the actual formula.
So, without further ado, here’s the formula!
Here is the formula for calculating straight-line depreciation:
Purchase Value – Salvage Value = Depreciation
Using this formula will get you the total depreciation cost you incurred using the asset. Basically, this is how much of the “cost” you’ve managed to use for the asset you own.
Suppose you want to calculate the annual depreciation for a certain asset, i.e., the amount that is deducted yearly. Here’s the formula you can use for it:
(Purchase Value – Salvage Value) / Useful Life = Depreciation
The formula will give you a figure of the depreciation cost incurred during each year that you had the asset for, whether you used it or not.
As per accounting rules, the amount you calculate using the depreciation expense formula needs to be subtracted from the asset’s value. The representation is as follows:
Depreciation – Asset Value = Book Value
The book value is the figure at which the asset is valued for the year.
However, the value will decrease each year because it’s directly proportional to the usage. You’ll be changing the value of “Useful Life” in the formula.
Example of Straight Line Method Of Depreciation
It’s essential for you to understand how the formula works and how to use it.
Let’s look at an example that will further remove any confusion you have regarding the formula and its values.
The case: You own a smartphone that you bought for $400 in 2016.
Now you’re also someone who loves switching to newer versions as they are released. So, you decide that you’ll be using the new smartphone for three years only.
Now according to you, the salvage value should be $150 in 2019.
Here’s how you will calculate the depreciation for your smartphone.
Annual Depreciation = $400 – $100 / 3 years
= $300 / 3 years
= $100 each year
The straight-line method indicates that your smartphone will be depreciating by $100 each year, should you decide to sell it in the year 2019.
Now, let’s play with some bigger values, shall we?
Let’s assume you buy a brand new car as an incentive for your top-performing employee.
You buy the car at a retail price of $350,000. It’s new, beautiful, and your employee loves it. However, you predict that once this employee gets promoted, you will need to upgrade it for them, so you estimate that your employee will have the car for ten years.
The next thing you predict is the salvage value you think it will be worth when this ten year period ends. You expect to sell it for $165,000 at the end of ten years. Here’s how the depreciation will be calculated:
Annual Depreciation = $350,000 – $165,000 / 10 years
= $185,000 / 10 years
= $18,500 each year
The car you’ve just bought for your employee will depreciate by $18,500 each year.
Why Choose Straight Line Depreciation?
Before choosing the straight-line method for depreciation, we’d like to tell you that there are several other depreciation methods that are in use across the accounting domain. These other methods are:
- Double Declining Methods
- Units Of Production
- Sum Of Years Digit
However, the easiest out of them all is the straight-line method, and that’s why a majority of businesses choose it.
And for people who don’t want to go through the hassle of handling accounts, they prefer other options.
For e.g. they can always opt for an outsourced bookkeeping service provider that can handle their accounting related tasks like depreciation, tax deductions, financial report preparation for them easily.
The Best Use Of The Straight Line Method
Businesses need to calculate depreciation because it is part of the yearly expense report. It’s added as an operating expense in the balance sheet, which is why it’s crucial to calculate it properly.
If you don’t add it then, you will have to make an adjusting entry for it at a later stage, which can be quite challenging if you don’t have the necessary expertise to accomplish such a task.
The method reflects on the consumption of every asset owned by a company or an individual.
The other methods show a depreciated value that is different each year, whereas depreciation through the straight-line method is only calculated once and it offers a constant value.
This method is best for assets that aren’t consumed or used in a particular manner. For example, you’ve had a car for ten years (as mentioned in the example above.)
You can’t put a value on how you have used the car.
There is no “right way” of using a car. It’ll be used the way it’s intended; however, it will wear out with every use, and that’s where the straight-line method of depreciation is highly recommended.
Accounting is not easy – it’s a tricky subject, with many different types of particulars to account for and numerous formulas to apply.
If you don’t do it, or do it wrong, you will face a lot of issues for e.g. during the recent Covid 19 Pandemic, the US government announced stimulus cheques for businesses going through a hard time. Businesses that didn’t have their books together had a really hard time applying for and getting their stimulus cheques approved.
So if you don’t have the expertise to manage your accounting on your own, then its best to outsource it to an online bookkeeping service provider who can not just calculate the depreciation on your fixed assets but also handle your entire accounting process including bookkeeping for you in a highly streamlined manner.