Straight-line method allocates the cost of asset to expense on equal basis to each period that benefit from use of asset during its useful life. In simple words, straight-line method steadily decrease the cost of asset over its useful life.
Straight-line method calculates depreciation expense in relation to time instead of actual use of asset. The depreciation charge from one period to the other will be same as the cost of the asset, useful life of the asset and the length of each period remains constant.
Formula to calculate straight-line depreciation is as follows:
|Straight-line depreciation for the period =||Cost – Expected residual value|
|Expected useful life of asset|
As straight-line method depreciates the asset at constant rate therefore, it is best suited in situations when asset is also reaping benefits at a constant rate. In reality however, this assumption does not hold true. It is hardly the case the use of asset will stay same and also the efficiency of asset will remain constant through its life which is quite inappropriate as assets’ efficiency suffer due to wear and tear of asset and thus rate of benefit falls with the passage of time.
Example 1 – Straight-line depreciation
Swat Tourism acquired a vehicle costing $20,000. It is expected that its useful life will be 10 years and by the end of it will fetch only $500.
Calculate depreciation for the first year using straight-line method
Vehicle has a depreciable amount of $19,500 (20,000 – 500). With 10 years of useful life, its depreciation per year can be calculated follows:
= 19,500 / 10 = $1,950 per year
The depreciation of vehicle will stay 1,950 every year for the 10 years if situation remains the same.
1 Straight-line depreciation for mid-year acquisition or disposal
Its not always the case that asset was in use for the whole year. If it was acquired or disposed during the year then ideally depreciation expense should be calculated only for the period it was in use instead of whole year.
For mid-year acquisition and disposals depreciation is calculated on the basis fraction of time that is relevant. For example only for specific months,weeks or days out of the whole year. To adjust the depreciation expense, a fraction is added to the formula mentioned above:
|Straight-line depreciation for the period =||Cost – Expected residual value||x||relevant N|
|Expected useful life of asset||Total N in the period|
Where N can be number of months, weeks or days.
If its months then total N in a year will be 12. If its on the basis of weeks then usually total number of weeks are taken as 52. If its on the basis of days then entity’s policy will decide if it has to take 360 days or 365 days a year.
In the absence of any information on entity’s policy, depreciation is usually calculated only for the period asset was in use and adjusting the expense by the fraction of period if necessary. However, entities may have specific policies regarding mid-year acquisition or disposal of asset. Sometimes entities have a policy to charge full depreciation in the year of acquisition even if it wasn’t available for whole year but no depreciation is charged in the year of disposal. Entity can even design a policy to charge no depreciation in the year purchase but full depreciation in the year asset is salvaged.
Example 2: Straight-line depreciation – Mid-year acquisition
Swat Tourism acquired a vehicle costing $20,000 during the year. It is expected that its useful life will be 10 years and by the end of it will fetch only $500.
Calculate depreciation for the first year using straight-line method if asset was acquired on first November and December 31 is financial year end.
Basic depreciation expense calculation will remain same. Depreciable amount is 19,500 (20,000 – 500) and useful life is 10 years therefore depreciation for the year will be:
= 19,500 / 10 = $1,950
Now depending on the type of fraction we will adjust the depreciation expense.
Asset was used for only two months i.e. November and December therefore only two month’s depreciation will calculated on proportionate basis out of total 12.
= 19,500 x 2/12 = $3,250
Assuming each month has 4 weeks and a year has 52 weeks in total, depreciation for 8 weeks will be calculated.
= 19,500 x 8/52 = $3,000
November and December makes total of 61 days. Assuming a year has 365 days the depreciation charge for the year will be calculated as follows:
= 19,500 x 61/365 = $3,259