(155) STRAIGHT LINE Method of Depreciation in 3 Steps!

Introduction to Depreciation

  • Depreciation: process of reducing the book value of tangible fixed assets.

  • Causes: use, wear and tear, time passage, and obsolescence.

Straight Line Depreciation

  • A fixed cost depreciation method where expenses are evenly spread over an asset's useful life.

  • Example: A farmer with tangible fixed assets that decrease in value over time.

  • Example Asset: Combine harvester costing $450,000 with a useful life of 12 years and a residual value of $90,000.

Steps to Calculate Straight Line Depreciation

Step 1: Gather Information

  • Asset details:

    • Cost: $450,000

    • Residual value: $90,000

    • Useful life: 12 years

Step 2: Create a Depreciation Schedule

  • A table with 5 columns:

    • Year: the accounting period

    • Opening Book Value: value at the start of the year

    • Depreciation Expense: annual depreciation amount

    • Accumulated Depreciation: total depreciation to date

    • Closing Book Value: value at the end of the year

Step 3: Calculate Depreciation Values

Opening Book Value

  • $450,000 (initial asset cost)

Depreciation Expense

  • Calculate using:

    • Straight-Line Depreciation Rate: 1 / Useful Life = 1 / 12 = 8.33%

    • Depreciable Cost: Asset Cost - Residual Value = $450,000 - $90,000 = $360,000

    • Annual Depreciation Expense: 8.33% * $360,000 = $30,000

Accumulated Depreciation

  • Year 1: $30,000 (same as depreciation expense)

  • Formula: Previous Year Accumulated Depreciation + Current Year Depreciation Expense.

Closing Book Value

  • Calculate as:

    • Closing Book Value = Opening Book Value - Depreciation Expense.

    • Example for Year 1: $450,000 - $30,000 = $420,000.

Depreciation Over Useful Life

  • Repeat the calculation for each year:

    • Year 2: Closing Book Value ($420,000) becomes Opening Book Value.

    • Fixed Depreciation Expense: $30,000/year.

    • Yearly values:

      • Year 2: Accumulated Depreciation = $60,000, Closing Book Value = $390,000.

      • End of Year 12: Closing Book Value = $90,000 (matches residual value).

Graphical Representation

  • Track the combine harvester's book value over time:

    • Initial Cost: $450,000

    • Residual Value: $90,000

    • Depreciable Cost: $360,000

    • Useful Life: 12 years.

Conclusion

  • Straight-line depreciation spreads costs evenly.

  • Other variable methods increase expenses in early years; to be covered in the next video.

  • Mention of a depreciation cheat sheet available.