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Straight Line Depreciation

Understand the Straight Line Depreciation Accounting Concept

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Straight Line Depreciation

In This Article
  • What is the definition of straight line depreciation?
  • What is the formula for straight line depreciation?
  • Under straight line depreciation, how can the annual depreciation expense be calculated?
  • How does straight line depreciation differ from accelerated 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 = (Purchase Price – Salvage Value) / Useful Life

Straight Line Depreciation 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.

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
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