Depreciation is often talked about, but not easily understood. The basic idea of accounting for depreciation is to spread the cost of a long term asset (also called a fixed asset) over the useful life of the asset rather than taking an expense for it all at once as is done with short term assets. Straight line depreciation is the simplest and most straightforward method for calculating depreciation and is easy to master and understand. Below, you will see the simple steps for how to calculate straight line depreciation and will be performing your own calculations in now time.
Things You Will NeedA long term asset to depreciate like a vehicle, machine or building.
A calculator or paper and pencil.
Step 1The first step in determining fixed asset depreciation using the straight line method is finding the following basic information:
Cost - this is the amount of money paid for the asset.
Useful life - the amount of time the asset will provide a benefit.
Salvage value - the amount of money that the asset can be sold for at the end of its useful life (many times the salvage value is zero).
Cost is usually known or given on a check or invoice. Useful life and Salvage value are a bit trickier and rely on estimates and past experiences with similar equipments. Companies estimate these figures and can change their mind and adjust depreciation in the future. For now, we will assume they are well defined values. You are almost ready to start calculating depreciation!
Step 2Once we have Cost, Useful life, and Salvage value then we can plug this information into the simple formula:
(Cost - Salvage value)/Useful life = Annual Depreciation
So as an example we will learn how to calculate straight line depreciation on a company truck with the following information. The truck cost $40,000 and will last 10 years at which point it can be sold for $5000.
Cost = $40,000
Useful life = 10 years
Salvage value = $5000
So by our formula:
($40,000 - $5000) / 10 = Annual Depreciation
($35,000)/10 = Annual Depreciation
$3500 = Annual Depreciation
These figures are easy to calculate with pen and paper but for other more complicated scenarios you may want to use a calculator. So, every year for the next 10 years the company will declare $3500 depreciation for this vehicle.
It's just that easy! Now you know how to calculate straight line depreciation!
This is the most basic of depreciation methods and there are many others. Most of the others allow for a quicker cost recovery in the first few years by yielding a higher depreciation figure. The IRS still has guidelines for depreciation as well and just because a company declares a certain amount of depreciation on the books does not mean they can declare the same amount on taxes. Understanding depreciation and how it affects taxes is use knowledge to possess.