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Straight-Line Method

This method of depreciation is quite common because it is the simplest to calculate. The formula for this method is

$\text{annual depreciation}=\text{depreciable value}/\text{useful life.}$

What is depreciable value ? It is calculated with the following formula:

$\text{cost}-\text{residual value}=\text{depreciable value.}$

• The cost includes all amounts that were spent to obtain the asset and get it ready to use.
• The residual value (RV) is the amount that you expect to be able to sell the asset for when you're done using it; it might also be called the "scrap value" or "salvage value". The word residual means "remainder" or "leftover."

Once you have the depreciable value, divide that number by the useful life to get the depreciation expense. In other words, divide by how long you intend to use the asset. The result will be a constant amount per period. The equation is

$\text{depreciation expense}=\text{depreciable amount}/\text{useful life.}$

Example of Straight-Line Depreciation

On January 1, 2017, your company purchased machinery for $50,000 cash. You've estimated that the machinery will last five years (estimated useful life). You've also estimated that the residual value of the machine at the end of five years will be $5,000. Calculate the depreciation expense, accumulated depreciation, and book value for each year during the five-year useful life of the asset and record the adjusting entry for 2017.

The depreciation expense for 2017 is calculated as follows:

• $\text{depreciation expense}=\frac{\text{cost}-\text{residual value}}{\text{useful life}}$
• $\text{depreciation expense}=(\$50,000-\; \$5,000)/5\text{years}$
• $$ depreciation expense = $ 9 , 000

The adjusting entry for depreciation expense on December 31, 2017 is shown below.

The table below shows the depreciation expense, balance in the accumulated depreciation account, and book value for this asset for all five years of its useful life. The calculations for accumulated depreciation and book value are shown below the value in the table.

The amount shown in the depreciation expense column is the dollar amount you will use for the adjusting entry to record depreciation expense for the year. The accumulated depreciation column shows the balance in the accumulated depreciation ledger account at the end of the year after the adjusting entry has been recorded. Book value at the end of each year equals the original cost of the asset minus the balance in accumulated depreciation at the end of the year. The dollar amount for book value will appear on the balance sheet at the end of the year.

At the end of the useful life of this asset (December 31, 2021), the balance in accumulated depreciation must equal the cost of the asset minus residual value, $45,000; the book value of the asset must equal the residual value, $5,000.

Partial-Year Depreciation

One issue to consider is the fact that very few purchases occur on January 1; most purchases occur throughout the year. You will need to compute a partial-year depreciation for any asset not purchased at the beginning of the year.

The common rounding method considers that, if you owned the asset for more than half the month, you are entitled to the depreciation for that entire month. If you purchase an asset on or before the 15th of the month, you can take the full month’s depreciation. If the asset is purchased after the 15th, you will treat it as if it were purchased at the beginning of the following month. You will calculate annual depreciation based on the number of months the asset is owned for the year.

Example: Straight-Line Depreciation (Partial Year)

On July 1, 2017, your company purchased machinery for $50,000 cash. You've estimated that the machinery will last five years (estimated useful life). You've also estimated that the residual value of the machine at the end of five years will be $5,000. Calculate depreciation expense for 2017 and 2018.

Depreciation expense for 2017 is calculated as follows:

• $\text{depreciation expense}=\frac{\text{cost}-\text{residual value}}{\text{useful life}}$
• $\text{depreciation expense (annual)}=(\$50,000-\; \$5,000)/5\text{years}$
• $$ depreciation expense (annual) = $ 9 , 000

Depreciation expense for 2017 is $4,500, calculated as follows:

• $\$9,000\times (6/12)=\$4,500$

The asset was purchased on July 1; therefore, it was in use for six months during 2017.

Depreciation expense for 2018, 2019, 2020, and 2021 is $9,000 per year. You will have a partial year (six months of depreciation) in 2022.