Straight Line Method Explanation, Formula and FAQs

straight line method equation

For example, there is always a risk that technological advancements could potentially render the asset obsolete earlier than expected. Find the equation of the line which passes through the points A(-2, 0) and B(1, 6) and state the gradient and y-interceptclosey-interceptThe value of the y-coordinate when a graph crosses the y-axis.. If a line forms a 90o angle with the x-axis, or the line is parallel to the y-axis, the slope of the line is not defined or infinite. If a line forms an angle that lies between 0o and 90o with the x-axis, the slope of the line is positive. The most common formulas to find equation of straight line are mentioned below.

In other words, companies can stretch the cost of assets over many different time frames, which lets them benefit from the asset without deducting the full cost from net income (NI). To calculate the straight line basis, take the purchase price of an asset and then subtract the salvage value, its estimated sell-on value when it is no longer expected to be needed. Then divide the resulting figure by the total number of years the asset is expected to be useful, referred to as the useful life in accounting jargon. It contrasts with the accelerated depreciation method, which recognizes a higher depreciation expense in the initial year of asset use. That way, with the accelerated depreciation method, companies get a higher tax reduction in the initial years of the asset. The declining balance method calculates more depreciation expense initially, and uses a percentage of the asset’s current book value, as opposed to its initial cost.

Step 6: Divide annual depreciation by 12 to calculate monthly depreciation

The slope of a line is specifically measured with the x-axis or a horizontal line. The angle formed by a line with a positive x-axis is the slope of a line. The lines which are drawn vertically and are parallel to the y-axis, or perpendicular to the x-axis, are called vertical lines. They form a 90o or 270o angle with the x-axis and a 0o or 180o angle with the y-axis. The lines which are drawn horizontally and are parallel to the x-axis or perpendicular to the y-axis, are called horizontal lines.

  • The angle formed by a line with a positive x-axis is the slope of a line.
  • These double entries are intended to reflect the continuous use of fixed assets over time.
  • The straight line basis simply allocates the expense equally into each period of its useful life, which smooths the expense and ultimately net income.
  • To calculate depreciation using a straight line basis, simply divide net price (purchase price less the salvage price) by the number of useful years of life the asset has.
  • Suppose an asset for a business cost $11,000, will have a life of 5 years and a salvage value of $1,000.
  • For example, let’s say that you buy new computers for your business at an initial cost of $12,000, and you depreciate their value at 25% per year.
  • And if you expect the asset to have a certain value even at the end of its life cycle, you would first subtract that residual value from the original cost.

The process of straight line depreciation involves the cost of acquisition of an asset as well as its potential future salvage value in years to come, as has been stated above. So, in order to expand on the topic of the depreciation method of Straight Line, these two aspects shall be understood first. We only need to estimate the residual value of the assets and the years of economic life.

Straight Lines – Important JEE Main Questions

They form a 0o or 180o angle with the x-axis and a 90o or 270o angle with the y-axis. A straight line is an endless one-dimensional figure that has no width. It is a combination of endless points joined on both sides of a point. If we draw an angle between any two points on the straight line, we will always get a 180-degree.

Therefore, in order to further this discussion about this particular method of straight line depreciation, the formula that has been established in relation to this method has hereby been stated. This method provides equal depreciation costs for each period over the useful life of assets. In a nutshell, the depreciation method used depends on the nature of the assets in question, as well as the company’s preference.

How do you calculate straight-line depreciation?

One quirk of using the straight line depreciation method on the reported income statement arises when Congress passes laws that allow for more accelerated depreciation methods on tax returns. From this case, the company will recognize a depreciation expense of Rp8 [(Rp100-Rp20) / 10] every year. The company reported a net asset value of Rp92 (Rp100-Rp8) in its balance sheet and a depreciation expense of Rp8 in the income straight line method equation statement at the end of the first year. You can avoid incurring a large expense in a single accounting period by using depreciation, which can hurt both your balance sheet and your income statement. A company buys a piece of equipment worth $ 10,000 with an expected usage of 5 years. Then the enterprise is likely to depreciate it under the depreciation expense of $2000 every year over the 5 years of its use.

However, the expenditure will be recorded in an incremental manner for reporting. This is done as the companies use the assets for a long time and benefit from using them for a long period. Therefore, although depreciation does not exhibit an actual outflow of cash but is still calculated as it reduces companies’ income; which needs to be estimated for tax purposes. We call the running total of depreciation expense “accumulated depreciation” and it will be equal to the historical cost less the estimated salvage value.

Intercept Form

The Straight Line Depreciation Method is the easiest method for calculating Depreciation. It is less prone to the risk of calculation errors since it does not involve complex calculations and data. Furthermore, it does not cause variation in each year’s Profit and Loss Statement as it provides Depreciation uniformly over its useful life.

Straight-line depreciation is suitable for cheaper goods, such as furniture. We calculate depreciation from the original cost minus the residual value of the asset, divided by the estimated useful life of the asset. Recording depreciation affects both your income statement and your balance sheet.

Slope Point form (Equation of a Line with 2 Points)

Also, while applying this method, the period of use of the asset should be considered. If an asset is used only for 3 months in a year then depreciation will be charged only for 3 months. However, for the Income Tax purposes, if an asset is used for more than 180 days full years’ depreciation will be charged. When the amount of depreciation and the corresponding period are plotted on a graph it results in a straight line. Here’s a hypothetical example to show how the straight line basis works.

  • Intangible assets are only amortized if they have limited useful years.
  • In other words, companies can stretch the cost of assets over many different time frames, which lets them benefit from the asset without deducting the full cost from net income (NI).
  • To calculate the depreciation of an asset, an asset’s salvage value is deducted from its purchase price the difference is then divided by the estimated useful years of the asset.
  • Depreciation is a method that allows the companies to spread out or distribute the cost of the asset across the years of its use and generate revenue from it.
  • Consequently, if we plot ln c against t we will obtain a straight line graph with gradient –k and intercept ln co.
  • Take the purchase price or acquisition cost of an asset, then subtract the salvage value at the time it’s either retired, sold, or otherwise disposed of.

The straight line basis is a method used to determine an asset’s rate of reduction in value over its useful lifespan. Other common methods used to calculate depreciation expenses of fixed assets are sum of year’s digits, double-declining balance, and units produced. Whereas, the form of declining balance depreciation involves the rate at which the value of the asset gets depreciated with time in the market.

Journal Entries for Straight Line Method of Depreciation

It’s the simplest and most commonly used depreciation method when calculating this type of expense on an income statement, and it’s the easiest to learn. Whether you’re creating a balance sheet to see how your business stands or an income statement to see whether it’s turning a profit, you need to calculate depreciation. While the purchase price of an asset is known, one must make assumptions regarding the salvage value and useful life. These numbers can be arrived at in several ways, but getting them wrong could be costly. Also, a straight line basis assumes that an asset’s value declines at a steady and unchanging rate.

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