Straight Line Depreciation Method (Definition, Examples)

What is the Straight Line Depreciation Method?

Straight Line Depreciation Method is one of the most popular methods of depreciation where the asset uniformly depreciates over its useful life and the cost of the asset is evenly spread over its useful and functional life. Thus, the depreciation expense in the income statement remains the same for a particular asset over the period. As such the income statement is expensed evenly, so is the value of the asset on the balance sheet. The carrying amount of the asset on the balance sheet reduces by the same amount.

Colgate’s Straight Line Depreciation Method

source: Colgate SEC Filings

Colgate follows the straight-line method of depreciation. Its assets include Land, building, machinery and equipment, all of them are reported at costs.
The useful life of machinery and equipment ranges from 3 to 15 years
The useful life of the building is a bit longer at 40 years.
Also, you should note that depreciation is not reported separately in Colgate. They are included either in Cost of Sales or Selling, general and admin expenses.

Formula

Straight-line depreciation method can be calculated using the following formula:

The straight-line method of calculating straight-line depreciation has the following steps:

Determine the initial cost of the asset at the time of purchasing.
Determine the salvage value of the asset i.e. the value at which the asset can be sold or disposed of after its useful life is over.
Determine the useful or functional life of the asset
Calculate depreciation rate i.e. 1/useful life
Multiply the depreciation rate by the cost of the asset minus the salvage cost

The value we get after following the above straight-line method of depreciation steps is the depreciation expense which is deducted on income statement every year till the useful life of the asset.

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Straight Line Depreciation Method Examples

Suppose a business has bought a machine for $ 10,000. They have estimated the useful life of the machine to be 8 years with a salvage value of $ 2,000.

Now, as per the straight line method of depreciation:

Cost of the asset = $ 10,000
Salvage Value = $ 2000
Total Depreciation Cost = Cost of asset – Salvage Value = 10000 – 2000 = $ 8000
Useful life of the asset = 8 years

Thus, annual depreciation cost = (Cost of asset – Salvage Cost)/Useful Life = 8000/8 = $ 1000

Hence, the Company will depreciate the machine by $1000 every year for 8 years.

We can also calculate the depreciation rate, given the annual depreciation amount and the total depreciation amount which is annual depreciation amount/total depreciation amount
Hence, depreciation rate = (annual depreciation amount/total depreciation amount)*100 = (1000/8000)*100 = 12.5%

Depreciation account of the balance sheet will look like below over the 8 years of the machine’s life:

Accounting

How to adjust the depreciation charges on the Balance sheet, Income statement and the cash flow statement?

As can be seen from the above table – At the end of 8 years i.e. after its useful life is over, the machine has depreciated to its salvage value.

Now, we will look into how this expense is charged on the Balance sheet, income statement and cash flow statement in detail. Let us take the above example of the machine:

When the machine is bought for $ 10000; the cash and cash equivalents are reduced by $ 10000 and moved to Property, plant and equipment line of the balance sheet.
At the same time, an outflow of $ 10000 is shown in the cash flow statement.
Now, $ 1000 will be charged to the income statement as a depreciation expense for 8 continuous years. Although, all the amount is paid for the machine at the time of purchase, however, the expense is charged over a period of time.
Every year $1000 is added to a contra account of balance sheet i.e. Property, plant, and equipment. This is called accumulated depreciation. This is to reduce any carrying value of the asset. Thus, after 1^st year the accumulated depreciation will be $ 1000, after 2^nd year it will be $ 2000 and so on…till the end of the 8^th year, it will be $ 8000.
After the useful life of the machine is over, the carrying value of the asset will be only $ 2000. The management will sell the asset and if it is sold above the salvage value a profit will be booked in the income statement or else a loss if sold below the salvage value. The amount earned after selling the asset will be shown as the cash inflow in the cash flow statement and the same will be entered in the cash and cash equivalents line of the balance sheet.

Advantages

It is the simplest method of depreciating an asset.
It is most commonly used and easy to understand method.
It does not involve complex calculations hence, chances of errors are less.
Since the asset is uniformly depreciated, it does not cause the variation in the Profit or loss due to depreciation expense while other depreciation methods can have an impact on Profit and Loss Statement variations.

Final Thoughts

In the article, we have seen how the straight line depreciation method can be used to depreciate the value of the asset over the useful life of the asset. It is the easiest and simplest method of depreciation where the cost of the asset is depreciated uniformly over its useful life.