At some point, you may need to buy equipment, tools, and other assets for your business. Those assets tend to wear out after several years and lose their value. Luckily, businesses can write off those expenses if they know about depreciation and how to calculate it.
The straight-line depreciation formula is the simplest and most common way to calculate depreciation. In this article, we’ll go over the basics of depreciation and show you how to calculate it with the straight-line depreciation formula.
What Is Depreciation?
Depreciation is the decrease of an asset’s value over time. You need to know about depreciation for tax purposes and to make sure financial statements are accurate. Business owners and accountants can use it to write off the costs of certain assets.
Depreciation is typically calculated using one of several methods. Most commonly, you’ll use the straight-line method or the declining balance method.
Tax considerations, accounting principles, or other factors will determine which method you should use.
What Is Straight-Line Depreciation?
Straight-line depreciation is more simple than the declining balance method.
The straight-line depreciation method spreads the cost evenly over the life of an asset. Each year, you expense the same percentage.
For example, let’s say a company purchases a $1,000 machine. The machine has a five-year useful life. The useful life represents how many years an asset will last. It’s also an estimate. Under the straight-line method, the machine would depreciate by $200 per year.
Then, you would report the depreciation expense on your company’s annual income statement for five years.
Straight-Line Depreciation Formula – How To Calculate It
To calculate an asset’s value, you need to know the straight-line depreciation formula and how to apply it. The straight-line depreciation formula is:
- Depreciation expense = (Asset cost – Residual value) / Useful life
Asset cost stands for the price at the time of purchase. For example, a golf course buys a cart for $12,000. The asset cost is $12,000.
The residual value is the asset’s estimated value by the time it reaches the end of its useful life. It is also sometimes called salvage value.
The straight-line depreciation formula can be used for any type of asset. However, it is most commonly used for depreciating business assets. This can include:
- Buildings
- Machinery
- Equipment
- Vehicles
- Furniture
You can use the formula to calculate your straight-line depreciation expense. It’s the amount that can be written off each year.
Straight-Line Depreciation Example
Consider an equipment purchase for $15,000. It has a useful life of five years. You estimate that at the end of five years, the equipment will have no value. The depreciation each year would be $3,000 (($15,000 – $0) / 5). A depreciation chart would look like:
| Beginning Value | Depreciation | Ending Value | |
| Year 1 | $15,000 | $3,000 | $12,000 |
| Year 2 | $12,000 | $3,000 | $9,000 |
| Year 3 | $9,000 | $3,000 | $6,000 |
| Year 4 | $6,000 | $3,000 | $3,000 |
| Year 5 | $3,000 | $3,000 | $0 |
Other Depreciation Methods
There are three main types of depreciation: straight-line, declining balance, and sum-of-the-years’ digits. We know that straight-line depreciation spreads the cost evenly over the life of the asset.
Although the straight-line method makes it easier to calculate depreciation, it does not reflect the true value or usage of an asset over time. For example, after you purchase a vehicle, you typically use it the most during the first few years. However, it can still have value several years after.
Let’s look at other methods.
Declining balance method
Declining balance depreciation considers that an asset will be used more often in the first few years, so it will lose value then.
You can calculate the declining balance method by multiplying a fixed depreciation rate by the current book value (CBV). The CBV is the asset’s estimated value in that accounting period.
If we look at the same example as above:
| Beginning Value | Depreciation | Ending Value | |
| Year 1 | $15,000 | $3,000 ($15,000 * 20%) | $12,000 |
| Year 2 | $12,000 | $2,400 ($12,000 * 20%) | $9,600 |
| Year 3 | $9,600 | $1,920 ($9,600 * 20%) | $7,680 |
| Year 4 | $7,680 | $1,536 ($7,680 * 20%) | $6,144 |
| Year 5 | $6,144 | $1,229 ($6,144 * 20%) | $4,915 |
Note that the declining balance method produces larger expenses in earlier years and smaller expenses in later years. There is also the double-declining balance method which uses twice the rate of depreciation (i.e. 40% in the example above).
You may use the declining balance method to depreciate assets that lose value and become obsolete quickly. For example, you might use it to calculate depreciation for computers since they have a shorter useful life.
Sum-of-the-years
The sum-of-the-years’ digits method is more complex. It provides a more accelerated schedule of depreciation than straight-line or declining balance methods.
You calculate the yearly deduction by multiplying a fraction (the sum of all digits used to represent time periods divided by time period) by the asset cost. Then, you minus any salvage value.
In our earlier example, you would calculate Year 1’s deduction by taking 5 divided by 5+4+3+2+1 multiplied by $15,000. You’d calculate Year 2’s deduction by taking 4 divided by (5+4+3+2) 5+4+3+2+1. Then, you multiply by $15,000. As you can see, this approach gets confusing. In most cases, you won’t need to use the sum-of-the-years.
| Beginning Value | Depreciation | Ending Value | |
| Year 1 | $15,000 | $5,000 ($15,000 * 5/(5+4+3+2+1)) | $10,000 |
| Year 2 | $10,000 | $4,000 ($15,000 * 4/(5+4+3+2+1)) | $6,000 |
| Year 3 | $6,000 | $3,000 ($15,000 * 3/(5+4+3+2+1)) | $3,000 |
| Year 4 | $3,000 | $2,000 ($15,000 * 2/(5+4+3+2+1)) | $1,000 |
| Year 5 | $1,000 | $1,000 ($15,000 * 1/(5+4+3+2+1)) | $0 |
When Do You Use the Straight-Line Method?
You should use the straight-line formula to depreciate an asset that steadily loses value each year. Assets like real estate and large equipment often use straight-line depreciation.
It’s simple to calculate. However, the downside is that it does not reflect the true cost of certain assets.
When you know what depreciation is and how to calculate it, you can recoup some costs for purchasing assets. Depreciation can also reduce the amount of taxes owed. Luckily, you don’t need to do all the bookkeeping and accounting to calculate depreciation. With xendoo, you can get an experienced bookkeeper, accountant, tax professional, and CFO all in one place. View our plans to decide which option is right for your business.
