Wall Street Prep

Straight Line Depreciation

Understand the Straight Line Depreciation Accounting Concept

Learn Online Now

Straight Line Depreciation

Straight Line Depreciation Definition

Depreciation is defined 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.

The concept of depreciation in accounting stems from the purchase of PP&E – i.e. capital expenditures (CapEx).

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.

Typically, the salvage value (i.e. the residual value that that asset could be sold for) at the end of the asset’s useful life is assumed to be zero.

Straight-Line Depreciation Formula
  • Straight-Line Depreciation = (Purchase Price – Salvage Value) / Useful Life

Straight Line Depreciation Calculator – Excel Template

We’ll now move to a modeling exercise, which you can access by filling out the form below.

Submitting ...

Straight Line Depreciation Calculation Example

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

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
  • Annual Depreciation = $50k

Straight-Line Depreciation Calculation

Step-by-Step Online Course

Everything You Need To Master Financial Modeling

Enroll in The Premium Package: Learn Financial Statement Modeling, DCF, M&A, LBO and Comps. The same training program used at top investment banks.

Enroll Today
Comments
guest
0 Comments
Inline Feedbacks
View all comments
Learn Financial Modeling Online

Everything you need to master financial and valuation modeling: 3-Statement Modeling, DCF, Comps, M&A and LBO.

Learn More
X

The Wall Street Prep Quicklesson Series

7 Free Financial Modeling Lessons

Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts.