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02 DEPRECIATION - Straight Line Method

The document discusses different historical depreciation methods used by businesses to deduct the cost of capital expenditures over time, including straight-line depreciation. Straight-line depreciation uniformly reduces the value of an asset over its useful life by dividing the depreciable amount (cost - salvage value) by the number of years of useful life to calculate the annual depreciation amount. The annual depreciation rate can also be calculated by dividing the annual depreciation amount by the total depreciable cost. An example is provided to demonstrate calculating straight-line depreciation for a machine.

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Dexter Javier
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719 views

02 DEPRECIATION - Straight Line Method

The document discusses different historical depreciation methods used by businesses to deduct the cost of capital expenditures over time, including straight-line depreciation. Straight-line depreciation uniformly reduces the value of an asset over its useful life by dividing the depreciable amount (cost - salvage value) by the number of years of useful life to calculate the annual depreciation amount. The annual depreciation rate can also be calculated by dividing the annual depreciation amount by the total depreciable cost. An example is provided to demonstrate calculating straight-line depreciation for a machine.

Uploaded by

Dexter Javier
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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DEPRECIATION

Straight Line Method

HISTORICAL DEPRECIATION METHODS


Allowing businesses to deduct the cost for capital expenditures over time (that is, to
depreciate business assets) has long been part of the tax code. However, over time several
versions of various depreciation methods have been used to calculate these deductions. In
general, accounting depreciation methods can be categorized as follows.

1. Pre-1981 historical methods


These methods include the straight-line, sum-of-the years' -digits, and declining balance
methods. Each method required estimates of an asset's useful life and salvage value. Firms could
elect to use any of these methods for assets, and thus there was little uniformity in how
depreciation expenses were reported.

2. 1981-1986 method 
With the Economic Recovery Tax Act (ERTA)of 1981,Congress created the accelerated
cost recovery system (ACRS). The ACRS method had three key features: 
1. property class lives were created and all depreciated assets assigned to one
particular category,
2. the need to estimate salvage values was eliminated because all assets were fully
depreciated over their recovery period, and
3. shorter recovery periods were used to calculate annual depreciation, which
accelerated the write-off of capital costs more quickly than did the historical
methods-thus the name.

3. 1986 to present
The modified accelerated cost recovery system (MACRS)has been in effect since the
Tax Reform Act of 1986 (TRA-86). The MACRS method is similar to the ACRS system except
that (1) the number of property classes was expanded and (2) the annual depreciation percentages
were modified to include a half-year convention for the first and final years.

WHAT IS STRAIGHT LINE DEPRECIATION?


The simplest and best known depreciation method is
straight-line depreciation. With the straight line depreciation
method, The value of an asset is reduced uniformly over each
period until it reaches its salvage value. Straight line
depreciation is the most commonly used and straightforward
depreciation method for allocating the cost of a capital asset.
It is calculated by simply dividing the cost of an asset, less its
salvage value, by the useful life of the asset.

STRAIGHT LINE DEPRECIATION FORMULA


To calculate the constant annual depreciation charge, the total amount to be depreciated,
B - S, is divided by the depreciable life, in years, N.
Where:
B - purchase price of the asset.
S - value of the asset at the end of its useful life.
N - number of periods/years in which the asset is expected to be used by the company.

On the other hand, the straight line depreciation rate can be calculated as follows:

Where:
d - annual depreciation charge.
B - purchase price of the asset.
S - is the value of the asset at the end of its useful life.

STEPS ON CALCULATING STRAIGHT LINE DEPRECIATION


i. Determine the cost of the asset.
ii. Subtract the estimated salvage value of the asset from the cost of the asset to get
the total depreciable amount.
iii. Determine the useful life of the asset.
iv. Divide the sum of step (2) by the number arrived at in step (3) to get the annual
depreciation amount.

EXAMPLE:

1. Company A purchases a machine for 100,000php with an estimated salvage value of


20,000php and a useful life of 5 years.

The straight line depreciation for the machine would be calculated as follows:

 Cost of the asset:


100,000php
 Cost of the asset – Estimated salvage value:
100,000php – 20,000php = 80,000php total depreciable cost
 Useful life of the asset:
5 years
 Divide step (2) by step (3):
80,000php / 5 years = 16,000php annual depreciation amount

Therefore, Company A would depreciate the machine at the amount of 16,000php annually for 5
years.
The depreciation rate can also be calculated if the annual depreciation amount is known. The
depreciation rate is the annual depreciation amount / total depreciable cost. In this case, the
machine has a straight-line depreciation rate of: 

Note how the book value of the machine at the end of year 5 is the same as the salvage value.
Over the useful life of an asset, the value of an asset should depreciate to its salvage value.

Figure A. Straight Line Depreciation

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