Explanation
Straight line depreciation method charges cost evenly throughout the useful life of a fixed asset.
This depreciation method is appropriate where economic benefits from an asset are expected to be realized evenly over its useful life.
Straight line method is also convenient to use where no reliable estimate can be made regarding the pattern of economic benefits expected to be derived over an asset’s useful life.
Formula
Straight line depreciation can be calculated using any of the following formulas:
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Depreciation per annum = |
Cost − Residual Value |
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|
Useful life |
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Depreciation per annum = |
( Cost − Residual Value ) x Rate of depreciation |
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Where:
- Cost is the initial acquisition or construction costs related to the asset as well as any subsequent capital expenditure.
- Residual Value, also known as its scrap value, is the estimated proceeds expected from the disposal of an asset at the end of its useful life. The portion of an asset’s cost equal to residual value is not depreciated because it is expected to be recovered at the end of an asset’s useful life.
- Useful Life is the estimated time period that the asset is expected to be used starting from the date it is available for use up to the date of its disposal or termination of use. Useful life is normally expressed in units of years or months.
- Rate of depreciation is the percentage of useful life that is consumed in a single accounting period. Rate of depreciation can be calculated as follows:
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Rate of depreciation = |
1 |
x 100% |
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Useful life |
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e.g. rate of depreciation of an asset having a useful life of 8 years is 12.5% p.a.
(1 ÷ 8) x 100% = 12.5% per year
Tip
Remember to adjust the depreciation expense downwards when an asset has been acquired or disposed off during the accounting period to avoid charging depreciation for the time the asset was not available for use. See Example 1 below.
Example 1
A fixed asset having a useful life of 3 years is purchased on 1 January 2013.
Cost of the asset is $2,000 whereas its residual value is expected to be $500.
Calculate depreciation expense for the years ending 30 June 2013 and 30 June 2014.
Depreciation expense per annum shall be: =
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= |
($2000 − $500) |
= $500 p.a |
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3 Years |
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Depreciation expense for the year ended 30 June 2013:
$500 x 6/12 = $250
As $500 calculated above represents the depreciation cost for 12 months, it has been reduced to 6 months equivalent to reflect the number of months the asset was actually available for use.
Depreciation expense for the year ended 30 June 2014:
$500 x 12/12 = $500
As the asset was available for the whole period, the annual depreciation expense is not apportioned.
Alternatively, you may express useful life in months and calculate depreciation charge as follows:
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Useful life in months = |
12 x 3 |
= 36 months |
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= |
($2000 − $500) |
= $41.67 p.m. |
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36 months |
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Depreciation expense for year ended 30 June 2013:
= $41.67 x 6 = $250
Depreciation expense for year ended 30 June 2014:
= $41.67 x 12 = $500
Revision in Estimates of Useful life and Residual Value
The estimates of useful life or residual value of an asset may need to be revised in subsequent accounting periods in order to reflect more accurately the pattern of economic benefits in light of new information.
In such cases, it will be necessary to account for the effects of revision in estimates prospectively, i.e. the change in depreciation expense is accounted for in the period in which the revision takes place and subsequent accounting periods (see Example 2 below).
Following formula can be used to calculate straight line depreciation for the current and subsequent accounting periods in case of a revision:
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Depreciation expense = |
( Cost - Revised Residual Value - Accumulated Depreciation) |
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Revised Remaining Useful Life |
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- Accumulated depreciation is the total depreciation that has been charged in previous accounting periods since the capitalization of the asset.
- Revised remaining useful life is the estimated number of useful years or months of the asset remaining since the last accounting period in which depreciation was charged.
Tip
Depreciation already charged in prior periods is not revised in case of a revision in the depreciation charge due to a change in estimates.
Refer IAS 8 for treatment of changes in accounting estimates.
Example 2
A fixed asset is purchased on 1 January 2011.
Information relating to the asset is as follows:
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Cost of acquisition |
$110,000 |
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Residual Value estimated at the time of acquisition |
$10,000 |
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Residual Value revised estimate on 1 January 2012 |
Nil |
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Useful Life estimated at the time of acquisition |
10 years |
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Useful Life revised estimate on 1 January 2013 |
8 years |
Calculate depreciation expense for the years ended 31 December 2011, 2012, 2013 & 2014
Depreciation expense for 2011:
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= |
$110,000*- $10,000** |
= $10,000 |
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10 Years*** |
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*Cost
**Residual Value
***Useful Life
Depreciation expense for 2012:
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= |
$110,000 - $0* - $10,000** |
= $11,111 |
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9 Years*** |
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*Residual Value (revised)
**Depreciation charged in the year 2011.
***Remaining Useful Life. Since depreciation for only 1 year has been charged so far, remaining useful life is equal to 9 years (10 – 1)
Depreciation expense for 2013:
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= |
$110,000 - $0 - $10,000 - $11,111* |
= $14,815 |
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6 Years*** |
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* Depreciation charged in the year 2012.
** Remaining Useful Life (revised). The revised estimate of useful life is 8 years. As depreciation has been charged for 2 years, the remaining useful life relevant to depreciation calculation is 6 years.
Depreciation expense for 2014 = $14,815*
* Depreciation for the year 2014 is equal to the depreciation expense charged in the year 2013 because there has been no change in estimates since then.
Quiz
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Question
Which of the following is true regarding Straight Line Depreciation?
It prevents bias in situations when the pattern of economic benefits from an asset is hard to estimate.
Correct.
Since straight line method charges cost of a fixed asset evenly over its entire useful life, it prevents deliberate manipulation of profits through the use of a depreciation method that either accelerates or decelerates the charge of depreciation expense even though the pattern of economic benefits expected to be derived from the use of the asset is uncertain.
Once straight line depreciation charge is determined, it is not revised subsequently.
Incorrect.
Although straight line depreciation charges the cost of fixed asset evenly over its useful life, the amount of charge may be revised as often as required to reflect changes in estimates involving the asset's useful life and residual value.