The Straight-Line Depreciation Method is the most commonly used method for allocating an asset’s cost evenly over its useful life. This method is simple to apply and provides consistent depreciation expenses each year. In this article, we explore a detailed example of how straight-line depreciation is calculated, recorded, and reflected in financial statements.
1. Understanding Straight-Line Depreciation
Formula:
Annual Depreciation = (Cost of Asset – Residual Value) ÷ Useful Life
- Cost of Asset: The purchase price of the fixed asset.
- Residual Value (Salvage Value): The expected value of the asset at the end of its useful life.
- Useful Life: The number of years the asset is expected to be used.
2. Example Scenario
A company purchases office equipment for $12,000. The equipment has an estimated useful life of 6 years and a residual value of $2,000 at the end of its life.
Step-by-Step Calculation:
Annual Depreciation = (12,000 – 2,000) ÷ 6
Annual Depreciation = $10,000 ÷ 6 = $1,666.67 per year
3. Depreciation Schedule
Depreciation is applied annually, and the accumulated depreciation increases each year while the asset’s book value decreases.
| Year | Depreciation Expense ($) | Accumulated Depreciation ($) | Book Value ($) |
|---|---|---|---|
| 1 | 1,666.67 | 1,666.67 | 10,333.33 |
| 2 | 1,666.67 | 3,333.33 | 8,666.67 |
| 3 | 1,666.67 | 5,000.00 | 7,000.00 |
| 4 | 1,666.67 | 6,666.67 | 5,333.33 |
| 5 | 1,666.67 | 8,333.33 | 3,666.67 |
| 6 | 1,666.67 | 10,000.00 | 2,000.00 (Residual Value) |
4. Journal Entry for Depreciation
Each year, depreciation is recorded as an expense to reflect the asset’s reduction in value.
Journal Entry:
Debit: Depreciation Expense $1,666.67
Credit: Accumulated Depreciation $1,666.67
5. Impact on Financial Statements
A. Income Statement
- Depreciation Expense of $1,666.67 is recorded each year, reducing net profit.
B. Balance Sheet
- The asset is listed at its original cost, with accumulated depreciation deducted to show its book value.
C. Cash Flow Statement
- Depreciation is a non-cash expense, so it is added back in operating activities.
6. Advantages of Straight-Line Depreciation
- Simple and Easy to Apply: Requires minimal calculations.
- Consistent Depreciation Expense: Helps in financial planning.
- Best for Assets with Uniform Usage: Suitable for buildings, furniture, and office equipment.
Applying Straight-Line Depreciation in Business
The Straight-Line Method is an effective way to allocate an asset’s cost evenly over time. It ensures that businesses recognize a consistent expense each year, making financial planning and reporting more predictable. This method is ideal for assets that depreciate steadily, such as office equipment, buildings, and machinery.