As computers, tools, peripherals, and other business equipment wears out over time, their value decreases – this concept is known as a depreciation in value. It’s essential that all businesses understand the various depreciation methods which may be applied when writing off the cost of expensive purchases during their annual tax filings.
Join us as we review the straight-line depreciation method, which is widely regarded as the most common depreciation methods for small business. We’ll discuss the formula for calculating straight line depreciation, and contrast it to other methods.
What is straight-line depreciation?
Straight-line depreciation is a basic method for calculating how much an asset loses value, or depreciates, over time.
The straight-line method of depreciation assumes a steady rate of depreciation, calculating a constant rate of depreciation over its useful life. Or stated otherwise, it depreciates an asset an equal amount over each year of its useful life.
Straight Line Depreciation Graph
A graph illustration will convey how simple this depreciation method is. Here’s what the depreciation pencils out to be for the 5-year useful life of the asset in our example described later:
This depreciation curve is flat, or straight, and that’ the basis for how this method was named – the straight-line depreciation method.
How to calculate straight-line depreciation
You need three numbers to calculate straight-line depreciation for a fixed asset:
- Purchase Price – The total purchase price of the asset, or the total cost of the asset with its associated costs such sales taxes, shipping costs, assembly costs, installation charges
- Salvage Value – The salvage value of the asset, or the price you expect it can be sold for at the end of its useful life.
- Useful Life – The useful life of the asset, or how many years you believe it will serve its purpose. The useful life is determined and provided by the IRS, which has provided acceptable useful life direction for most depreciable assets grouped into property classes. In our article discussing useful life we share the IRS useful life table for commonly depreciated items.
Not sure if your asset qualifies for depreciation? View our article titled What Property Can Be Depreciated? for more.
Straight Line Depreciation Formula
To calculate the straight-line depreciation rate for your asset, subtract the salvage value from the asset cost to get total depreciation, then divide that by useful life to get annual depreciation. In other words, take what you paid, deduct its fair market value after its useful life to you, and divide that by the number os years it will be useful, like this:
Annual Depreciation = (Purchase Price – Salvage Value) / Useful Life (in years)
An Example of Straight-line Depreciation
Let’s walk through an example to illustrate how this depreciation works.
In this example, we’ll refer to the common example of a business purchasing a computer. Here are the scenario details:
- Computer purchase price is $1800
- Computer has a useful life of 5 years (IRS Code 179 states computers should be depreciated over 5 years)
- After 5 years you expect to be able to sell the computer for $300 (AKA. it’s estimated salvage value)
Calculating the straight-line depreciation of the computer, is determined as follows:
Annual Depreciation = (Purchase Price – Salvage Value) / Useful Life (in years)
= ($1800 – $300) / 5 years
= $1,500 / 5 years
= $300 depreciation per year for 5 years, or like this:
Year 1 Depreciation = $300
Year 2 Depreciation = $300
Year 3 Depreciation = $300
Year 4 Depreciation = $300
Year 5 Depreciation = $300
How is straight-line depreciation different from other methods?
Straight line depreciation is popular in large part due to its simplicity, however, there are other depreciation models which may be better suited to the asset you will be depreciating given that items many depreciate more rapidly in at the beginning of their useful life, or perhaps more at the end of their life.
When that’s the case, the alternative models – the double declining depreciation method, the sum of years method, or the unit-of-production method – may be the more appropriate method to apply. Sure, straight line depreciation is by far the simplest, but simpler is not always better.
Depreciation Method Comparison
Here’s an illustration comparing 3 depreciation methods – straight line depreciation, double declining depreciation, and sum of years deprecation:
Straight Line Depreciation | Double Declining Depreciation | Sum of Years Depreciation | |
Year 1 Depreciation | $300 | $720 | $500 |
Year 2 Depreciation | $300 | $432 | $400 |
Year 3 Depreciation | $300 | $259 | $300 |
Year 4 Depreciation | $300 | $89 | $200 |
Year 5 Depreciation | $300 | $0 | $100 |
Total Depreciation | $1500 | $1500 | $1500 |
Depreciation Method Comparison Graph
For those who prefer graphs to tables, here’s a graph comparing these three depreciation methods:
While the double declining depreciation, and sum of years deprecation methods realize more depreciation at the beginning of an asset’s life, the straight line method realizes the same depreciation each and every year.
Depreciable items which lose their value earlier, or later, in their useful life would benefit from the alternative depreciation methods. Examples of this are automobile depreciation (or delivery van depreciation), or rental property depreciation.
Straight Line Depreciation Conclusions
The straight line depreciation model is simple, and useful. It’s important to select the method that that best applies to the item you wish to depreciate.
Expert Help
When it’s time to select a depreciation method, consider enlisting the help of a CPA as depreciation can be complex, and this is merely an introduction. An experienced CPA will be able to guide you through the process, avoiding costly mistakes along the way, and assist you with the completion of Form 4562 and other depreciation related forms.