ZIMSEC O Level Principles of Accounts Notes: Calculating/Estimating depreciation: 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
  • \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.