Straight-Line Method of Depreciation
Depreciation is the method with the help of which the value of the asset is diminished over its useful life. This method helps the business in reducing the value of the assets with its respective use, and the value of the assets is decreased in the financial statements, which provides the true and fair view of the investments held in the business. The decrease in the value of assets is known as depreciation expense and this cost is charged to the asset to decrease its value.
Companies can calculate the depreciation of assets with many methods, and all of these are valid. The company policy defines the method of depreciation it is going to use, and it is not mandatory for the company to use one method for the depreciation of all its assets. It is up to company to choose the method of depreciation for every asset, although IFRS does provide a guideline in the selection of depreciation methods. Following are the different depreciation methods:
- Straight- line method
- Reducing balance method
- Fixed percentage method
- Sum-of-years’ digit method
Straight-line method of depreciation is the most popular and simple method of depreciation. In this method, the purchase price or the acquisition value of the asset is divided by the useful life of the asset after deducting the scrap value from the value of an asset.
Scrap value of the assets is the value of the asset at which it can be sold after its useful life is over.
In order to understand the straight-line method of depreciation better, here is an example:
Suppose that you purchase a car for $1000. The scrap value of the car after its useful life is $200, and the useful life of the car is 4 years. In order to calculate the depreciation of the car for the year 1, you will need to perform the following computation:
Depreciation = (1000-200)/4 = $200Since this is straight-line depreciation, you need to subtract this value from the balance sheet for the next 4 years in order to calculate the net book value of the asset.