How to Calculate Depreciation Using the Straight-Line Method

Depreciation is an accounting process for allocating the cost of a tangible asset over its productive period, aligning with U.S. Generally Accepted Accounting Principles (GAAP). Instead of recording the full expense of a major purchase at once, a business spreads it across the years the asset is in service. The straight-line method is the most common approach to calculating this annual expense. It evenly distributes the cost over the asset’s lifespan, resulting in the same depreciation amount being recorded each period.

Key Components for Calculation

The first component is the asset’s full cost. This includes the purchase price plus all expenditures required to get the asset ready for use, such as sales tax, shipping charges, and installation fees. For example, the cost of a new machine would include the price paid to the vendor, transport fees, and the expense of installation and testing.

Another component is the asset’s estimated salvage value. This figure represents the expected residual worth of the asset at the end of its time with the business. It is an estimate of the price the company could get if it sold the asset after it is no longer needed for primary operations. For instance, a delivery vehicle might be sold for parts after five years of service. This value reduces the total amount of cost that needs to be depreciated.

The final piece of information is the asset’s useful life. This is the estimated duration, in years, that a business expects to use the asset in its operations. This is not the asset’s total physical lifespan but its service life to that company, based on factors like industry norms and past experience. A company might use a computer for three years before upgrading, even though it could physically last longer.

The Straight-Line Formula and Example

The formula for the straight-line method is: (Asset Cost – Salvage Value) / Useful Life. The result is the annual depreciation expense that will be recorded each year. This approach ensures that the depreciable base, which is the asset’s cost minus its salvage value, is spread evenly across its productive period.

To illustrate, imagine a business purchases equipment. The total capitalized cost, including the purchase price of $10,500 and $500 in shipping fees, is $11,000. The company estimates it will use the equipment for five years and expects a salvage value of $1,000. Plugging these numbers into the formula gives: ($11,000 – $1,000) / 5 years, which yields an annual depreciation expense of $2,000. For monthly statements, the business would divide this by 12 for an expense of approximately $166.67.

Recording Depreciation Expense

Once the annual depreciation amount is calculated, it must be recorded in the company’s accounting records through a journal entry. This entry involves a debit to an account called Depreciation Expense and a credit to an account called Accumulated Depreciation. The debit increases expenses on the income statement, which in turn reduces the company’s reported net income for the period.

The corresponding credit increases the Accumulated Depreciation account, which is a contra asset account shown on the balance sheet. This account is paired with the related asset account and its balance is subtracted from the asset’s original cost. The purpose is to show the reduction in the asset’s value over time without removing the historical cost from the books.

The result of this process is the calculation of the asset’s book value, which is its historical cost minus its accumulated depreciation. Using the previous example, after the first year, the equipment’s book value would be $9,000 ($11,000 cost – $2,000 accumulated depreciation). After the second year, the accumulated depreciation would total $4,000, and the book value would decrease to $7,000. This continues until the book value equals the estimated salvage value at the end of the asset’s useful life.