What is Straight Line Depreciation?
Straight Line Depreciation is the reduction of a long-term asset’s value in equal installments across its useful life assumption.
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How to Calculate Straight Line Depreciation (Step-by-Step)
- Purchase Cost: The initial cost of purchasing the fixed asset, i.e. the capital expenditure (Capex)
- Useful Life: The number of years in which the fixed asset is anticipated to offer economic benefits
- Salvage Value (“Scrap Value”): The residual value of the fixed asset at the end of its useful life
Taking a step back, the concept of depreciation in accounting stems from the purchase of PP&E – i.e. capital expenditures (Capex).
Further, depreciation can be thought of as the gradual decline in value of a fixed asset (i.e. property, plant & equipment) over its useful life, which is the estimated duration that the asset is expected to provide economic benefits.
Under the matching principle in accrual accounting, the costs associated with an asset with long-term benefits must be recognized in the same period for consistency.
Hence, the depreciation line item – which is typically embedded within either cost of goods sold (COGS) or operating expenses (OpEx) – is a non-cash expense, as the real cash outflow occurred earlier when the Capex was spent.
There are a couple of accounting approaches for calculating depreciation, but the most common one is straight-line depreciation.
Straight Line Depreciation Formula
In the straight line method of depreciation, the value of an asset is reduced in equal installments in each period until the end of its useful life.
The formula consists of dividing the difference between the initial CapEx amount and the anticipated salvage value at the end of its useful life by the total useful life assumption.
Straight Line Depreciation Calculator – Excel Model Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Step 1. Purchase Cost, Useful Life and Salvage Value Assumptions
Let’s say, for instance, that a hypothetical company has just invested $1 million into long-term fixed assets.
According to management, the fixed assets have a useful life of 20 years with an estimated salvage value of zero at the end of their useful life period.
- Purchase Cost = $1 million
- Useful Life = 20 Years
- Salvage Value = $0
Step 2. Annual Depreciation Calculation (Straight Line Basis)
The first step is to calculate the numerator – the purchase cost subtracted by the salvage value – but since the salvage value is zero, the numerator is equivalent to the purchase cost.
After dividing the $1 million purchase cost by the 20-year useful life assumption, we get $50k as the annual depreciation expense.
- Annual Depreciation = $1 million / 20 years = $50k