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Straight line depreciation is the simplest way to allocate the cost of an asset over several years in fixed asset accounting. The straight-line metho

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Straight line depreciation is the simplest way to allocate the cost of an asset over several years in fixed asset accounting. The straight-line method calculates annual depreciation by dividing the cost of the fixed asset by its useful life. Thus, an equal amount of the asset’s costs is deducted as depreciation expense against profit and loss during each year of the asset’s life. The vast majority of non-manufacturing small businesses use straight line depreciation because of the simplicity and reasonable allocation of costs over years.

How to calculate straight line depreciation

When calculating straight-line depreciation, we consider three elements:

  1. Cost of the fixed asset: The cost of the asset is its purchase price after deduction of discount taken, plus sales tax, shipping costs, insurance, and so on.
  2. Useful life: Useful life is the estimated time that the fixed asset will remain in service.
  3. Recycling value: This is the estimated resale or disposal value of the asset after its useful life.

The formula for annual straight-line depreciation is:

Straight-line depreciation=Cost – Storage Value Useful life

Useful lives

If you are unsure or unable to arrive at an estimated useful life for a newly acquired asset, one option is to use the life given in IRS Publication 946. Although these lives are to be used for income tax purposes, they are not required for accounting purposes.

Source: IRS

When to use straight line depreciation

The simplicity of straight line depreciation is best for the following circumstances:

  • Businesses looking for an easy depreciation method: The formula of straight line depreciation is easy to use and remember. It shares the depreciable cost of the asset over its useful life.
  • Businesses with no heavy equipment and machinery: The use of heavy equipment and machinery is often linked to intensive operations and manufacturing. A more appropriate depreciation method for heavy use may be the double-declining balance method or the unit of production method for manufacturers.
  • Best for businesses that own intangible assets: Patents, copyrights and trademarks are examples of intangible assets using the straight-line method. Since it is assumed that these intangible assets are used throughout their legal life, the straight-line method is the only method to allocate the cost of intangible assets.
  • Best for office equipment and other indoor fixed assets: Fixed assets that are not exposed to elements are not prone to serious damage or destruction. The straight-line method is the best method of estimating the allocation of costs over time.

Straight Line Depreciation Example

Let’s assume we acquired a fixed asset for $ 50,000 with an estimated salvage value of $ 5,000 at the end of its 10-year useful life.

Step 1: Calculate the depreciable cost

The depreciable expense is the cost of the asset net of its recoverable amount. Since we expect to sell the asset at its estimated recoverable amount, we will not include that amount in depreciation.

Step 2: Calculate the depreciation expense

Using the formula above, we can calculate the annual depreciation expense by replacing the variables with our given amounts:

Straight-line depreciation

=

$ 45 000 10 years

=

$ 4,500 a year

That’s why we allocate $ 4,500 of the cost of depreciation expenses each year. Our depreciation costs go to accumulated depreciation, which offsets the cost account of the fixed asset on the balance sheet.

Clue: Depreciation does not predict or measure the value of an asset. In our example above, we do not necessarily expect the equipment to be worth $ 45,000 after one year. Depreciation is a way of allocating the $ 50,000 cost over several years, instead of deducting it all when the asset is purchased.

Group method

There are cases where assets used in businesses are interrelated. For example, office desks, chairs, tables and copiers are often used together. It therefore makes sense to depreciate them as a group instead of depreciating them individually. You can do this by using the straight-line approach under the group method.

The group method of depreciation mixes similar and interrelated assets in one depreciation rate. Let us examine the following example:

Below is the list of related assets used by ABC Company.

In the list of assets provided by ABC Company, we noted that each fixed asset has different useful lives. Let’s look at asset # 4. The useful life of this fixed asset is four years. This means that we expect to retire the asset earlier than asset # 2. But since these assets are interrelated, it would be contradictory to depreciate them individually.

So let’s use the group method to write them off as if they were a single asset.

Step 1: Depreciable cost and individual straight-line depreciation

Let’s add two more columns to expand our analysis.

Step 2: Calculate the group rate

The group rate is the weighted average rate of useful life of the fixed assets. We calculate it as follows:

Group rate

=

Total individual depreciation Total cost of all assets

=

$ 15,900 $ 120 000

=

13.25%

Step 3: Calculate the group life

The group life determines how long we are going to depreciate the group assets based on its group depreciation.

Group life

=

Total deductible expenses Total individual depreciation

=

$ 112 000 $ 15,900 / year

=

7.04 years (or 7 years)

The group life simply indicates that the useful life of our group assets is seven years. As we depreciate similar assets as a group, we ignore their individual useful lives and rather appreciate them over group life.

Step 4: Record the journal entry

Grouped assets can be merged into one asset account. Our entry to record group depreciation will be:

We are recording $ 15,900 per year, which after seven years will be $ 111,300. We will raise the final $ 700 in year eight to reach the total cost of $ 112,000. The small amount of depreciation in year eight is due to the group life which in Step 3 is slightly longer than seven years.

Can QuickBooks help me keep up with depreciation?

QuickBooks Enterprise has a fixed asset manager that automatically calculates your depreciation costs. You can also store other information such as asset number, date of purchase, cost, purchase description, serial number, warranty expiration date and others.

Bottom Line

The straight-line method of depreciation offers small business owners an easy and simple formula for depreciation. Setting up your small business accounting system can help you choose the right method that matches the usage pattern of your fixed assets if you know your depreciation methods.

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