Straight Line Depreciation: How To Calculate & Formula
Tim is a Certified QuickBooks Time (formerly TSheets) Pro, QuickBooks ProAdvisor, and CPA with 25 years of experience. He brings his expertise to Fit Small Business’s accounting content.
Eric is a staff writer at Fit Small Business and CPA focusing on accounting content. He spends most of his time researching and studying to give the best answer to everyone.
This article is part of a larger series on Bookkeeping.
Straight line depreciation is the simplest way to allocate the cost of an asset over multiple years in fixed asset accounting. The straight line method calculates annual depreciation by dividing the cost of the fixed asset by its useful life. Thus, an equal amount of the asset’s cost is deducted as depreciation expense against profit and loss during each year of the asset’s life. The vast majority of nonmanufacturing small businesses use straight-line depreciation because of its simplicity and reasonable allocation of costs across years.
How To Calculate Straight Line Depreciation
In computing straight line depreciation, we consider three elements:
- Cost of the fixed asset: The cost of the asset is its purchase price net of discounts taken, plus sales taxes, shipping costs, insurance, and so on.
- Useful life: Useful life is the estimated length of time the fixed asset will remain in service.
- Salvage value: It’s the estimated resale or disposal value of the asset after its useful life.
The formula for annual straight line depreciation is:
| Straight line depreciation | = | Cost – Salvage value Useful life |
Useful Lives
If you’re unsure or unable to arrive at an estimated useful life for a newly acquired asset, one option is to use the lives given in IRS Publication 946. While these lives are required to be used for income tax purposes, they aren’t required for bookkeeping.
Recovery Period | Types of business equipment |
|---|---|
Three-year property | Tractor units, race horse more than two years old, any other horse more than 12 years old when placed in service, and qualified rent-to-own property |
Five-year property | Cars, taxis, buses, trucks, computers, office equipment―computers, calculators, and copiers, for example―research equipment, cattle, appliances, carpets, furniture, any machinery equipment used in farming, certain geothermal, solar, and wind energy property |
Seven-year property | Office furniture and fixtures like desks, files and safes; used agricultural machinery and equipment placed in service after 2017; grain bins, cotton ginning assets, or fences used in a farming business; and railroad truck |
10-year property | Vessels, barges, tugs, and similar water transportation equipment; any single-purpose agricultural or horticultural structure; any tree or vine bearing fruits or nuts; and qualified small electric meter and qualified smart electric grid system |
15-year property | Certain improvements made directly to land or added to it, such as shrubbery, fences, roads, sidewalks, and bridges, and any retail motor fuels outlet |
20-year property | Farm buildings other than single-purpose agricultural or horticultural structures |
Source: IRS
When To Use Straight Line Depreciation
The simplicity of straight line depreciation is best for the following circumstances:
- Businesses looking for an easy depreciation method: The formula of straight line depreciation is easy to use and remember. It’s dividing the depreciable cost of the asset over its useful life.
- Businesses with no heavy equipment and machinery: The use of heavy equipment and machinery is often linked to intensive operations and manufacturing. A more appropriate depreciation method for heavy use might be the double-declining balance method or the units of production method for manufacturers.
- Best for businesses that own intangible assets: Patents, copyrights, and trademarks are examples of intangible assets that utilize the straight line method. Since these intangible assets are assumed to be used throughout their legal life, the straight line method is the only method to allocate the costs of intangible assets.
- Best for office equipment and other indoor fixed assets: Fixed assets not exposed to elements aren’t prone to severe damage or destruction. The straight line method is the best method to estimate the allocation of cost over time.
| PROS | CONS |
|---|---|
| Easy and straightforward | Not ideal for heavy equipment and machinery that decline in value quickly |
| Fixed depreciation charges each year | Not ideal for equipment with erratic usage |
| Can be used for computing group depreciation for interrelated assets | Not ideal for equipment where units produced can be measured easily |
Straight Line Depreciation Example
Let’s assume that we acquired a fixed asset for $50,000 with an estimated salvage value of $5,000 at the end of its 10-year useful life.
Step 1: Compute the depreciable cost
The depreciable cost is the cost of the asset net of its salvage value. Since we expect to sell the asset at its estimated salvage value, we won’t include that amount in depreciation.
Depreciable cost | = Cost - Salvage value |
= $50,000 - $5,000 | |
Depreciable cost | = $45,000 |
Step 2: Compute the depreciation expense
By using the formula above, we can compute the annual depreciation expense by replacing the variables with our given amounts:
|
Straight line depreciation |
= |
$45,000 10 years |
| = |
$4,500/year |
Therefore, we allocate $4,500 of the cost to depreciation expense every year. Our depreciation charges go to accumulated depreciation, which offsets the cost account of the fixed asset on the balance sheet.
Tip: Depreciation doesn’t forecast or measure the value of an asset. In our example above, we don’t necessarily expect the equipment to be worth $45,000 after one year. Depreciation is a way to allocate the $50,000 cost over multiple years, instead of deducting it all when the asset is purchased.
Group Method
There are instances wherein assets used in businesses are interrelated. For example, office desktops, chairs, tables, and copiers are often used together. Hence, it’s sensible to depreciate them as a group instead of depreciating them individually. You can do that by using the straight line approach under the group method.
The group method of depreciation commingles similar and interrelated assets into one depreciation rate. Let’s examine the following example:
Below is the list of interrelated assets used by ABC Company.
Asset | Cost | Salvage Value | Estimate Useful Life |
|---|---|---|---|
1 | $25,000 | $1,250 | 10 years |
2 | $40,000 | $2,000 | 8 years |
3 | $30,000 | $3,000 | 6 years |
4 | $10,000 | $1,000 | 4 years |
5 | $35,000 | $5,000 | 2 years |
In the list of assets provided by ABC Company, we observed that each fixed asset has different useful lives. Let’s take a look at asset #4. The useful life of this fixed asset is four years. It means that we expect to retire the asset earlier than asset #2. But since these assets are interrelated, it would be inconsistent to depreciate them individually.
Hence, let’s use the group method to depreciate them as if they’re a single asset.
Step 1: Depreciable cost and individual straight line depreciation
Let’s add two more columns to extend our analysis.
Asset ID | Cost (A) | Salvage Value (B) | Depreciable Cost (A - B) | Estimate Useful Life (C) | Individual Depreciation (A - B) ÷ C |
|---|---|---|---|---|---|
1 | $25,000 | $1,000 | $24,000 | 10 years | $2,400 |
2 | $40,000 | $2,000 | $38,000 | 8 years | $4,750 |
3 | $30,000 | $3,000 | $27,000 | 6 years | $4,500 |
4 | $10,000 | $1,000 | $9,000 | 4 years | $2,250 |
5 | $5,000 | $1,000 | $4,000 | 2 years | $2,000 |
Total | $120,000 | $8,000 | $112,000 | $15,900 |
Step 2: Calculate the group rate
The group rate is the weighted average rate of the useful lives of the fixed assets. We compute it as follows:
|
Group rate |
= |
Total individual depreciation Total cost of all assets |
| = |
$15,900 $120,000 |
|
| = |
13.25% |
Step 3: Calculate the group life
The group life determines how long we’re going to depreciate the group of assets based on its group depreciation.
|
Group life |
= |
Total depreciable cost Total individual depreciation |
| = |
$112,000 $15,900/year |
|
| = |
7.04 years (or 7 years) |
The group life simply suggests that the useful life of our group assets is seven years. Since we’re depreciating similar assets as a group, we ignore their individual useful lives and instead depreciate them over the group life.
Step 4: Record the journal entry
Grouped assets can be pooled into one asset account. Our entry to record group depreciation would be:
Date | Description | Debit | Credit |
|---|---|---|---|
12/31 | Depreciation expense Accumulated depreciation - Group Assets | $15,900 | $15,900 |
We record $15,900 per year, which after seven years will be $111,300. We’ll record the final $700 in year eight to arrive at the total cost of $112,000. The small amount of depreciation in year eight is due to the group life being slightly longer than seven years in Step 3.
Can QuickBooks Help Me Keep Track of Depreciation?
QuickBooks Enterprise has a fixed asset manager that computes your depreciation expense automatically. You can also store other information like asset number, purchase date, cost, purchase description, serial number, warranty expiration date, and others.
Bottom Line
The straight line method of depreciation provides small business owners with an easy and simple formula for depreciation. In setting up your small business accounting system, knowing your depreciation methods can help you choose the right method that matches the pattern of usage of your fixed assets.
