Cambrige Notes: Principles of Accounting: The straight line method

• As already pointed out there are number of ways in which depreciation can be calculated
• The straight line method is merely one of these methods
• It is the most popular and simplest method of calculating depreciation there is
• First the cost of the asset is ascertained
• which is easy if the asset is purchased by the business it’s cost is the total cost expended in acquiring the asset
• Then the estimated useful life of the asset is determined/estimated
• Finally the estimated residual value i.e. the value at which we expect to sell the asset at the end of it’s useful life is determined/estimated
• The yearly depreciation is then calculated using the formula:
• \mathrm{\dfrac{Cost -Residual \quad Value}{Useful \quad Life\quad in\quad years}}
• The amount depreciation yielded by this formula is then charged each year in the Income Statement until the asset is disposed of

Simple example

• On 1 January 20×7 J Banda bought a second hand lorry for $10 000
• The lorry is expected to be used in the business for 5 years whereupon it will be sold for an estimated $2 000

Required

1. Calculate the yearly depreciation for the lorry to be shown in the books of J Banda

Solution

• First ascertain the cost which in this case is clearly $10 000
• Then determine the useful life which is 5 years
• Then residual value which in our case is $2 000
• Depreciation would be
• \mathrm{\dfrac{10000 -2000}{5}}
• $1 600/per year

Advantages

• It is simple to calculate and implement
• It is simple to understand even to non accountants
• The same amount of depreciation is charged to the Income Statement every year allowing for easier year on year comparison of profits
• The method can be applied to all manner of assets
• It is a widely accepted method of depreciation

Disadvantages

• Does not accurately reflect how usage of the asset varies from period to period
• Is not suitable for rapidly evolving assets that are susceptible to change in technology
• Does not reflect the increasing maintenance cost of the the asset in later years

To access more topics go to the Principles of Accounting Notes.