STRAIGHT LINE DEPRECIATION— MEANING, EXAMPLE, ADVANTAGES AND DISADVANTAGES

The straight line method of depreciation is a depreciation method where the depreciable amount of an asset is shared evenly over its periods of use.

It is a form of depreciation where an equal amount is allocated each year for depreciation.

Straight line depreciation is the simplest and commonest method of depreciation.

It is based on the assumption of a constant rate of depreciation.

Straight line depreciation works like this: we compute an asset's depreciation for the first year, then continue to depreciate it by the same amount until the asset is no longer useful.

Straight line depreciation is also called fixed instalment depreciation 

If we are to represent straight-line depreciation on a graph, it will be a straight line because the rate of depreciation is constant

The formula for calculating straight-line depreciation is as follows:

$\text{Depreciation}=\frac{\text{Cost-scrap value}}{\text{Estimated useful life}}$

The cost of the asset is the asset's cost plus any other incidental expenses which are required to put the asset to its optimum use.

The incidental expenses may include installation expenses, import duties, legal expenses and freight expenses

The scrap value of an asset is the amount that is expected to be realized from the disposal of the asset at the end of its useful life.

Also known as residual value or salvage value, scrap value is calculated as the difference between the asset's cost and total depreciation at the end of its useful life.

The useful life of an asset is the length of time that a company expects to use an asset for earning revenue.

It is not easy to obtain the useful life of an asset, that is why it is always estimated.

Example

On 1st January 2012, Michael Limited purchased equipment for N100,000. The equipment has a four-year estimated useful life and an N10,000 residual value.

Assuming 22.5% depreciation is made on a straight line basis, calculate the annual depreciation charges, accumulated depreciation for each year and the net book value last at the end of 2015.

Solution:

The annual rate of depreciation is calculated thus:

$=\frac{22.5}{100}×N100,000=N22,500$

Year Book value (year start)Annual depreciationAccumulated depreciation Book value (year-end)
2012 N100,00022,50022,500N77,500
2013 N77,50022,50045,000N55,000
2014 N55,00022,50067,500N32,500
2015 N32,50022,50090,000N10,000

To answer the question, the annual depreciation charge is N22,500. 

Secondly, Year 1, year 2, year 3, and year 4 have accumulated depreciation of N22,500, N45,000, N67,500, and N90,000, respectively

Lastly, the net book value at the end of 2015 is N10,000 which is the same as its scrap value.

Advantages Of The Straight Line Method

1. It is very simple: Straight line method of depreciation is very simple and easy to understand because the depreciation rate and charges are constant from year to year.

This makes it easy to see the effect of depreciation on the net profit (or loss) of a business

Indeed, the straight line method of depreciation is one of the commonest methods of depreciation due to its simplicity.

2. It allows the cost of an asset to be completely depreciated: In the straight line method of depreciation, the full cost of an asset can be depreciated.

That is, an asset can be depreciated up to zero scrap value.

Straight line depreciation ensures that the full cost of an asset can be completely written off.

3. It is suitable when an asset's useful life can be accurately measured: Leasehold property, patent and copyright are some of the assets whose existence depends on the contract, making their use very easy to measure.

Leasehold property and copyright are examples of assets whose existence is contingent on a contract, making their useful life easy to measure.

In such cases, straight-line depreciation is highly recommended and advisable

Disadvantages of straight line method.

1. The depreciation amount does not correspond to the services rendered: The depreciation amount of straight-line line depreciation does not equal the value of the services rendered by the asset.

Because assets' efficiency degrades over time, they generally provide more services during their early life than they do later in life.

Since straight line depreciation uses a constant rate of depreciation, the depreciation expenses cannot be adjusted to reflect the decrease in the service rendered by the asset over time.

2. It ignores interest: The straight-line method of depreciation fails to account for the interest obtained on the money invested in the asset.

3. Difficult to estimate: This is another drawback of the straight line method of straight-line method of depreciation.

It is very difficult to correctly determine the useful life or scrap value of an asset.

How do you calculate the depreciation charge correctly if you can't accurately predict the useful life of an asset?

4. Not suitable for all assets: Depreciation is not suitable for all assets, particularly, long-lived assets like buildings whose useful life is difficult to estimate.

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