A straight line basis is a common and straightforward method for calculating the depreciation of an asset over its useful life.
The straight line basis is a depreciation method used to calculate the wearing out of an asset's value over its serviceable lifespan by assuming an equal depreciation expense each accounting period. This approach simplifies the process of allocating the cost of an asset, such as machinery, vehicles, or buildings, evenly across the periods it benefits the company. Companies use the straight line basis to expense the value of an asset over accounting periods to reduce net income, which can impact tax liabilities.
How Does Straight Line Basis Work?
This method assumes that an asset loses its value at a consistent rate each year until its value is reduced to its salvage value (the estimated value of the asset at the end of its useful life). The formula for calculating straight-line depreciation is simple:
Depreciation Expense = (Cost of Asset - Salvage Value) / Useful Life of Asset
- Cost of Asset: The original purchase price of the asset, plus any costs incurred to get it ready for use.
- Salvage Value: The estimated residual value of the asset at the end of its useful life.
- Useful Life of Asset: The estimated number of years or periods the asset is expected to be used.
Example
Imagine a company purchases a machine for $50,000. They estimate its useful life to be 5 years and its salvage value to be $5,000.
Using the straight line basis:
Depreciation Expense = ($50,000 - $5,000) / 5 years
Depreciation Expense = $45,000 / 5 years
Depreciation Expense = $9,000 per year
Each year for 5 years, the company would record $9,000 in depreciation expense.
Why Do Companies Use Straight Line Basis?
- Simplicity: It's the easiest depreciation method to understand and calculate.
- Consistency: Provides a predictable and consistent expense recognized each period.
- Reduced Net Income: As mentioned in the reference, expensing the asset's value helps reduce net income, which can have tax implications.
Straight Line vs. Other Methods
While straight line basis is simple, other methods exist, such as declining balance or sum-of-the-years'-digits. These methods often result in higher depreciation expense in the earlier years of an asset's life and lower expense in later years. The choice of method can depend on the asset type and the company's accounting strategy.
Choosing the appropriate depreciation method is crucial for accurate financial reporting and tax planning. The straight line basis remains popular due to its ease of use and consistent expense recognition.
