Depreciation Calculation under Straight Line Method

Under the straight line method, depreciation is calculated based on the assumption that the asset's value decreases evenly over its useful life. This method is widely used as it is simple and easy to understand. Let's delve into the details of how depreciation is calculated under this method.

Step 1: Determine the Cost of the Asset
The first step in calculating depreciation under the straight line method is to determine the cost of the asset. This includes the purchase price, transportation costs, installation charges, and any other costs incurred to put the asset into its working condition.

Step 2: Determine the Useful Life of the Asset
The useful life of an asset refers to the estimated period over which it is expected to generate economic benefits. It is important to estimate the useful life accurately as it impacts the calculation of depreciation. The useful life can be determined based on factors such as industry standards, historical experience, and technological advancements.

Step 3: Calculate the Annual Depreciation Expense
Once the cost and useful life of the asset are determined, the annual depreciation expense can be calculated using the following formula:

Annual Depreciation Expense = (Cost of the Asset - Residual Value) / Useful Life

The residual value is the estimated value of the asset at the end of its useful life. It represents the salvage value or the amount that could be obtained by selling the asset after its useful life.

Step 4: Record Depreciation Expense
Depreciation expense is recorded in the books of accounts to reflect the reduction in the value of the asset over time. It is usually debited to the depreciation expense account and credited to the accumulated depreciation account. The accumulated depreciation account is a contra-asset account that offsets the cost of the asset on the balance sheet.

Example:
Let's consider an example to illustrate the calculation of depreciation under the straight line method. Suppose a company purchases a machine for $10,000 with a useful life of 5 years and a residual value of $2,000. The annual depreciation expense would be calculated as follows:

Annual Depreciation Expense = ($10,000 - $2,000) / 5 = $1,600

Therefore, the company would record an annual depreciation expense of $1,600 until the machine's useful life is completed.

Conclusion
The straight line method of depreciation calculates the expense in a systematic and uniform manner over the useful life of an asset. By following the steps mentioned above, businesses can accurately calculate and record depreciation expense, which helps in reflecting the true value of assets on the balance sheet.