Straight-Line Method of Depreciation

The straight-line method of depreciation allocates the depreciable cost of a long-lived asset in equal amounts to each period of its useful life. Depreciable cost is the asset's cost minus its estimated salvage value. Because the charge is the same every year, a graph of the asset's book value over time falls in a straight line, which gives the method its name.

It is by far the most widely used method for financial reporting under both US GAAP and IFRS, because it is simple to calculate and easy to understand, and because many assets, such as buildings, office furniture and leasehold improvements, provide roughly equal benefit in each year of use. It is also the standard method for amortizing most intangible assets with finite lives.

The annual charge is:

• $\text{Cost}$ is the purchase price plus all costs needed to get the asset ready for use, such as delivery, installation and testing.
• $\text{Salvage value}$ is the estimated amount the business will receive when it disposes of the asset, net of disposal costs.
• $\text{Useful life}$ is the number of years, or months, the business expects to use the asset.

The method can also be expressed as a rate: an asset with a five-year life is depreciated at 20 percent of its depreciable cost each year.

A bakery buys an oven for $46,000 and pays $4,000 for delivery and installation, so its cost is $50,000. The oven is expected to last eight years and then be sold for $6,000. Annual depreciation is $50,000 minus $6,000, divided by 8, or $5,500.

Each year the bakery records a debit to depreciation expense and a credit to accumulated depreciation for $5,500. After eight years the book value equals the salvage value, and no further depreciation is recorded even if the oven stays in use, at which point it is fully depreciated.

If the oven is bought on 1 April and the bakery's year ends on 31 December, the first year's charge covers nine months: $5,500 times 9 divided by 12, or $4,125. Some businesses use simpler conventions, such as a half year of depreciation in the year of purchase and the year of disposal.

• The declining-balance method and the double-declining balance method charge more depreciation in early years and less later, a form of accelerated depreciation suited to assets that lose value quickly, such as vehicles and computers.
• The units-of-production method ties depreciation to actual use, such as machine hours or miles driven, so the charge varies with activity.
• Over the full life, every method charges the same total, cost minus salvage value; only the timing differs.

Straight-line depreciation produces smoother profits than accelerated methods, which is one reason it is popular for financial reporting. For US federal income tax, however, most equipment is depreciated under MACRS, which uses accelerated rates by default, so book depreciation and tax depreciation often differ, giving rise to deferred taxes. Residential rental property and nonresidential real property are depreciated on a straight-line basis for tax, over 27.5 and 39 years respectively.

The method assumes benefits are evenly spread, which may not be true for assets that are used heavily in early years or need more repairs as they age. Estimates of useful life and salvage value are judgments; if they change, the remaining book value is spread over the revised remaining life as a change in accounting estimate. Assets must also be tested for impairment if their value falls sharply, regardless of the depreciation method used.