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Straight-Line Method (Depreciation Methods) in Financial Accounting
The straight-line (SL) method allocates an equal amount of depreciation expense to each year in an asset’s life. This method is based on the rationale that each year benefits equally from the asset’s services.
To illustrate, assume that a machine has a cost of $4,900, an economic life of five years, and an estimated residual value of $400. Residual value (or salvage value) is the amount the firm expects to receive from selling the asset at the end of its useful economic life.
Useful economic lives and residual values are estimates. Both are affected by the physical deterioration an asset is expected to undergo and by technological obsolescence. The latter effect is well illustrated by computers. Computers can physically perform their tasks for extended periods of time (perhaps a decade or more), but due to rapid advances in the computer industry, computers frequently become outdated. This affects both the length of time a firm expects to use a computer (its economic life) and the estimated residual value when the computer is taken out of service.
Annual straight-line depreciation expense is calculated by first subtracting the residual value from the cost. This difference is the depreciable basis. Next divide the depreciable basis by the number of years in the asset’s estimated useful life:
Annual depreciation expense = (Historical cost - Residual value) / Number of years
= $4,900 - $400 / 5 years
= $900 per year
To record depreciation expense, the asset is decreased and shareholders’equity is decreased by an expense. Although Chapter 2, “The Basic Concepts of Financial Accounting,” suggested that the asset account should be decreased, actual practice uses a contra-asset account called accumulated depreciation.
On the balance sheet, accumulated depreciation is deducted from the cost of property, plant, and equipment, and the difference, called the book value (or property, plant, and equipment, net), is included in total assets. After the preceding analysis, for example, the book value is $4,000:
Historical cost = $4,900
Less accumulated depreciation = - $900
Book value = $4,000
Depreciation expense, accumulated depreciation, and book value over the five years can be summarized as follows:
Depreciation Methods and Topics
- Straight-Line Method (Depreciation Methods)
- Sum-of-the-Years’-Digits Method (Depreciation Methods)
- Declining-Balance (DB) Methods (Depreciation Methods)
- Tax Depreciation
- Selection of Depreciation Method
- Misconceptions About Depreciation
Property, Plant, and Equipment (PPE) Topics
- Property, Plant and Equipment (PPE)
- Initial Valuation of Property, plant, and equipment (PPE)
- Depreciation of Property, plant, and equipment (PPE)
- Expenditures After Acquisition - Property, plant, and equipment (PPE)
- Disposals of Property, plant, and equipment (PPE)
- Write-Downs - Property, plant, and equipment (PPE)
- Financial Statement Presentation of Property, plant, and equipment (PPE)
- Utilization of Property, plant, and equipment (PPE)
- Percentage of PPE Depreciated (Age)
- Evaluation of the Accounting for Property, Plant, and Equipment (PPE)
Related Noncurrent Assets Topics
