How to Use the Straight Line Depreciation Formula

Depreciation systematically allocates the cost of a tangible asset over its useful life. Rather than expensing the entire cost in the year of purchase, its cost is spread out over the periods it benefits the business. The straight-line method is widely used due to its simplicity and consistent cost allocation.

Identifying Necessary Information

Calculating straight-line depreciation requires three pieces of information. The initial cost includes the purchase price and all expenditures necessary to bring the asset to its intended use. This encompasses shipping fees, installation charges, and testing costs. For instance, if a machine costs $50,000, plus $2,000 for delivery and $3,000 for installation, its initial cost for depreciation is $55,000.

Salvage value is the estimated amount an asset is expected to be worth at the end of its useful life. This estimate can sometimes be zero if the asset has no resale value. Businesses often rely on industry data, past experience, or expert appraisals to determine this estimate.

Useful life is the estimated period, typically expressed in years, over which the business expects to use the asset to generate revenue. This estimate considers physical wear and tear, technological obsolescence, and legal or contractual limits on its use. Companies frequently refer to IRS guidelines, industry standards, or their own historical data to determine a reasonable useful life. For example, a computer might have a useful life of three to five years, while a building could be twenty to forty years.

Applying the Straight-Line Formula

The straight-line depreciation formula is: (Initial Cost – Salvage Value) / Useful Life. This calculates the annual depreciation expense, evenly distributing the asset’s depreciable value over its estimated service period.

First, calculate the depreciable base of the asset by subtracting the estimated salvage value from the initial cost. This base represents the total amount of the asset’s cost that will be expensed over its useful life. For example, if an asset costs $60,000 and has an estimated salvage value of $10,000, its depreciable base is $50,000.

Once the depreciable base is determined, the second step is to divide this amount by the asset’s useful life, which is typically expressed in years. The result of this division is the annual depreciation expense. This expense will be recorded on the company’s income statement each year, reducing the asset’s book value on the balance sheet. The book value is the asset’s initial cost less its accumulated depreciation.

Working Through an Example

A manufacturing company purchases new production machinery. The initial cost of the machinery, including the purchase price, delivery fees, and installation, amounts to $120,000. The company estimates the machinery will have a salvage value of $20,000 at the end of its operational period.

The company’s engineers and management determine that the machinery has an estimated useful life of five years before it becomes obsolete or requires significant replacement. With these figures identified, we can now apply the straight-line depreciation formula. First, calculate the depreciable base by subtracting the salvage value from the initial cost: $120,000 (Initial Cost) – $20,000 (Salvage Value) = $100,000 (Depreciable Base).

Next, divide the depreciable base by the useful life to find the annual depreciation expense: $100,000 (Depreciable Base) / 5 years (Useful Life) = $20,000 per year. This means the company will recognize $20,000 in depreciation expense for this machinery each year for five years. This annual expense reduces the asset’s book value on the balance sheet and is reported on the income statement.

Over the five years, the machinery’s book value would decrease consistently. At the end of Year 1, the book value would be $100,000 ($120,000 initial cost – $20,000 accumulated depreciation). By the end of Year 5, the accumulated depreciation would total $100,000, leaving the machinery with a book value of $20,000, which equals its estimated salvage value. This systematic reduction reflects the asset’s declining economic utility over time.