Straight Line Depreciation

Our business assets lose their value as they grow old and hence we need to account for their loss of value. This is where the depreciation calculation comes in. The two most common methods of calculating depreciation are the straight line method and reducing balance method.

Depreciation

You know that an asset loses its value over its productive life. The loss of value is attributable to a variety of factors such as wear and tear and obsolescence of technology. Hence, by the time the assets runs out of its productive life, it will no longer command the price it did, at the time of purchase, and you'll be selling it away for a significantly lower price and at times, even for free.

Now according to the accounting principles, the value of the asset on the balance sheet should be equal to the value which it commands today, should it be sold. So if you purchased an asset 5 years ago for $50,000, it is unlikely that it still commands the same value today. Hence if the balance sheet says that the value of the asset is $50,000 today, it would be incorrect.

This instance proves that calculating depreciation is important because it helps the business ascertain the correct market value of its assets.

Using the Straight Line Method

In the straight line depreciation method, the user of the asset decides how many years he intends on using the asset. He may ascertain the usable life of the asset, based on his experience with the particular asset, or may decide the depreciation rate based on what the law decrees it to be.

For the sake of this example, we will assume that you have an asset worth $20,000 and you estimate that it will be useful to you for about 10 years. Then, you'll be writing off (depreciating) 20000/10, $2,000 each year towards depreciation. The whole point of it is to reduce the same amount each year. Hence depreciation is calculated as, value at the time of purchase/number of years of usable life.

On the other hand, if the laws in your country state that an asset has to be depreciated at a certain rate by the straight line method, then they will prescribe the rate of depreciation and you will have to depreciate it accordingly. In this case the number of years of usable life become a lot more dependent on the straight line depreciation rate. The calculated rate is the percentage of the purchase value which will be deducted every year. So if the rate is 10%, then the asset will last for 10 years. If the rate is 20%, it will last for 5 years and so on.

Depreciation Table

It is always in your best interests to keep a depreciation table for all your assets so that you have a ready record of how much depreciation you're charging each year and how much of the asset value is still remaining. Here's a sample, with the depreciation rate assumed to be 25% each year.

Year	Value of the Asset	Rate of Depreciation (on purchase amount)	Amount of Depreciation	Value of Asset Carried Forward
2005	$10,000	25%	$2,500	$7500
2006	$7500	25%	$2,500	$5,000
2007	$5,000	25%	$2,500	$2,500
2008	$2,500	25%	$2,500	$0

You can use this method to accurately calculate the projected depreciation. I hope this article and the example helped you understand the straight line depreciation method and how you can use it effectively.