Straight Line Basis Calculation Explained, With Example

The company will record the equipment in its general ledger account Equipment at the cost of $17,000. One of the most obvious pitfalls of using this method is that the useful life calculation is often based on guesswork. For example, there is always a risk that technological advancements could potentially render the asset obsolete earlier than expected. If the results of calculating the basis were graphed, it would appear as a straight line, hence the name. The straight-line basis is the simplest way to determine the loss of value of an asset over time. There are various accounting softwares that help in calculating the same accurately and quickly.

Consistent expense allocation

For example, a company will have a Cash account in which every transaction involving cash is recorded. A company selling merchandise on credit will record these sales in a Sales account and in an Accounts Receivable account. The “sum-of-the-years’-digits” refers to adding the digits in the years of an asset’s useful life. For example, if an asset has a useful life of 5 years, the sum of the digits 1 through 5 is equal to 15 (1 + 2 + 3 + 4 + 5). We will illustrate the details of depreciation, and specifically the straight-line depreciation method, with the following example. Accountants often say that the purpose of depreciation is to match the cost of the truck with the revenues that are being earned by using the truck.

This number will show you how much money the asset is ultimately worth while calculating its depreciation. Now that you have calculated the purchase price, life span and salvage value, it’s time to subtract these figures. You can calculate the asset’s life span by determining the number of years it will remain useful.

How These Assets are Recorded

Therefore, you should always consult with accounting and tax professionals for assistance with your specific circumstances. After an asset’s depreciation is recorded up to the date the asset is sold, the asset’s book value is compared to the amount received. For example, if an old delivery truck is sold and its cost was $80,000 and its accumulated depreciation at the date of the sale is $72,000, the truck’s book value at the date of the sale is $8,000. For financial statements to be relevant for their users, the financial statements must be distributed soon after the accounting period ends. Depreciation is recorded in the company’s accounting records through adjusting entries.

This account balance or this calculated amount will be matched with the sales amount on the income statement. A current asset whose ending balance should report the cost of a merchandiser’s products awaiting to be sold. The inventory of a manufacturer should report the cost of its raw materials, work-in-process, and finished goods. The cost of inventory should include all costs necessary to acquire the items and to get them ready for sale. The book value of an asset is the amount of cost in its asset account less the accumulated depreciation applicable to the asset. The book value of an asset is also referred to as the carrying value of the asset.

Example of Straight Line Basis

Understanding straight-line depreciation is crucial for businesses to accurately account for the gradual reduction in the value of their assets over time. Straight-line depreciation is used to evenly allocate the cost of an asset over its useful life, resulting in a consistent expense using the straight-line depreciation method. To calculate the depreciation expense, you subtract the asset’s salvage value from its initial cost and divide it by its useful life. The depreciation expense is recorded on the income statement, helping to reflect the asset’s decreasing value accurately. Understanding the straight-line depreciation method is essential for businesses to manage their balance depreciation method and financial reporting effectively. It means that the asset will be depreciated faster than with the straight line method.

While the upfront cost of these items can be shocking, calculating depreciation can actually save you money, thanks to IRS tax guidelines. Straight-line depreciation is one of the four accepted methods for Generally Accepted Accounting Principles (GAAP). Adopting one of the methods preferred by GAAP, like straight-line depreciation, can help ensure compliance for your financial statement.

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Note that the estimated salvage value of $8,000 was not considered in calculating each year’s depreciation expense. In our example, the depreciation expense will continue until the amount in Accumulated Depreciation reaches a credit balance of $92,000 (cost of $100,000 minus $8,000 of salvage value). The straight-line basis is also an acceptable calculation method because it renders fewer errors over the life of the asset. Unlike more complex methodologies, such as double declining balance, this method uses only three variables to calculate the amount of depreciation each accounting period. Regardless of the depreciation method used, the total depreciation expense (and accumulated depreciation) recognized over the life of any asset will be equal. However, the rate at which the depreciation is recognized over the life of the asset is dictated by the depreciation method applied.

• This method calculates depreciation by looking at the number of units generated in a given year.
• For example, a company will have a Cash account in which every transaction involving cash is recorded.
• Note that the account credited in the above adjusting entries is not the asset account Equipment.
• This method can be used to depreciate assets where variation in usage is an important factor, such as cars based on miles driven or photocopiers on copies made.

Depreciation expenses are recorded on your income statement, reducing reported profit or net income, which is crucial for tax calculations and assessing financial performance. The straight-line method’s popularity stems from its simplicity straight line depreciation example and ease of calculation. It provides a clear and consistent way to spread the cost of an asset over its expected lifespan, making it ideal for assets with a steady and predictable usage pattern. This makes it a preferred choice for businesses that value financial planning and reporting consistency.

We may earn a commission when you click on a link or make a purchase through the links on our site. All of our content is based on objective analysis, and the opinions are our own. Note how the book value of the machine at the end of year 5 is the same as the salvage value.

Hence, it is important to understand that depreciation is a process of allocating an asset’s cost to expense over the asset’s useful life. The purpose of depreciation is not to report the asset’s fair market value on the company’s balance sheets. The “declining-balance” refers to the asset’s book value or carrying value (the asset’s cost minus its accumulated depreciation).

The content on this website is provided “as is;” no representations are made that the content is error-free. The book value of bonds payable is the combination of the accounts Bonds Payable and Discount on Bonds Payable or the combination of Bonds Payable and Premium on Bonds Payable. A record in the general ledger that is used to collect and store similar information.

The estimated period over which an asset is expected to be used, known as its useful life, is vital in calculating straight-line depreciation. It dictates how the asset’s cost spreads over time, and adjustments to the useful life can significantly affect depreciation expenses. Salvage value, the estimated residual value of an asset at the end of its useful life, plays a crucial role in straight-line depreciation calculations.