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Straight line depreciation is a formula used to calculate the cost of an asset over time. It’s based on the assumption that all future cash flows are known and not subject to change, but can be calculated using just one variable: Depreciation Rate.
The “depreciation calculator” is a tool that will calculate the straight-line depreciation of an asset. Straight-line depreciation is the method used to calculate the amount of money that should be spent on an asset over its useful life. The formula for calculating straight-line depreciation is:
The easiest technique to determine an asset’s loss of value (or depreciation) over time is to use a straight line. It’s an accounting term for spreading the expense of an item equally across many years. It may also be used to figure out income tax deductions, but only for certain assets such as nonresidential real estate, patents, and software.
What Is Straight Line Depreciation and How Does It Work?
The cost of an object is spread out equally across its useful life using straight line depreciation. For example, if you spend $25,000 on a machine that you’ll use for five years, you may deduct $5,000 for each year the equipment is utilized. (Unless there’s a Value of Salvage, which we’ll discuss further down.)
This distinguishes straight line depreciation from other approaches (such as Double Declining Balance or Sum of the Years Digits), which reflect a larger cost early on and a lower cost later on. These approaches are frequently recommended for products that lose their value quickly, such as autos and electronics.
Straight line depreciation’s key benefit is its simplicity, as well as the fact that it may be utilized to deduct SOME things from your taxes. Next, we’ll go through when you should employ straight depreciation.
When should you use straight line depreciation?
Straight line deprecation may be used in two ways:
1. To be able to claim a tax deduction
You can’t usually write off the whole cost of a fixed item for your company in the first year, such as a car, computer, or furnishings. Instead, you must stretch the deduction out throughout the time period in which you will be utilizing it.
Section 179, for example, allows you to deduct the whole cost of specific assets in a single year (up to $500,000 overall). If you don’t qualify for Section 179 or your purchases total more than $500,000, you’ll need to find another way to pay.
The IRS allows you to deduct assets over numerous years using the straight line technique. The great majority of the time, though, you’ll utilize MACRS, which is a distinct way. Intangible assets like as software and copyrights, as well as nonresidential real estate, are often valued using the straight line technique.
2. For the sake of accounting
Depreciation might be recorded on your books as well. You don’t have to depreciate fixed assets for accounting reasons if you utilize the cash basis accounting technique (you still have to depreciate assets for tax purposes on your tax return). However, if you buy costly assets for your company and don’t account for depreciation, your financial statements may not fairly represent how well your company is doing.
This is why many businesses maintain two sets of books. Your tax-adjusted basis books are based on the value of an asset for internal or external use, while your book-adjusted basis books are based on the value of an asset for internal or external use (e.g. showing your profits to investors or lenders). You could utilize straight line depreciation for both your tax deduction and your books, depending on what assets you’re depreciating. For your taxes and books, you might employ alternative depreciation strategies.
What Is Straight Line Depreciation and How Do I Calculate It?
The majority of individuals will not calculate depreciation since they have a CPA or a tax software package like TurboTax to handle it for them. However, understanding how the calculation works is beneficial. The formula for computing straight line depreciation is as follows:
Depreciation expenditure per year =
(Fixed asset cost base – Salvage) / Estimated usable life
- The whole cost of the item, including taxes, delivery, and so on, is the The Asset’s Cost Basis.
- Estimated asset Value of Salvage – How much you’ll sell it for after you’ve finished utilizing it (if anything).
- The asset’s Estimated Time of Use is the length of time you’ll utilize it, usually measured in years.
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Let’s take a closer look at each of these:
The Asset’s Cost Basis
The The Asset’s Cost Basis will generally include all of the expenses that you incurred to get the asset up and running for use in your business. This includes but is not limited to any shipping or delivery costs, installation charges, sales tax and other indirect costs. For example, if you purchased a machine and had to get someone to come out and run tests before you could use it, that should also be included in the calculation of the cost basis of the machine.
The method for calculating an asset’s cost basis is simple: combine all of these figures together:
Cost basis of an asset is the item’s cost plus sales tax, shipping and delivery costs, installation fees, and other expenses.
Value of Salvage
The Value of Salvage is the estimated amount the asset will be worth if you were to sell it at the end of its useful life. For example, if you had a car that you wanted to trade in for a new one, the value of the old car would be based on the Kelley Blue Book value, which is what the dealer will pay you (Value of Salvage) for that car.
Estimated Time of Use
The Estimated Time of Use is the amount of time you expect an asset to last. Sometimes an asset may last longer than you expect it to and other times it may not. It really depends on the wear and tear on the asset as you use it over the years.
Based on the kind of business asset bought, the IRS has offered a reference to the recovery time (useful life). The IRS has specified depreciation recovery periods, which are summarized in the table below. In the table below, I’ve included properties for 3, 5, and 7 years. The complete list of properties, however, may be found in IRS Pub 946.
Business Equipment Depreciation Recovery Periods
Putting Everything Together
Once you have the The Asset’s Cost Basis, the Estimated Time of Use, and Value of Salvage, use the formula below for calculating straight line depreciation:
Depreciation expenditure per year =
(Fixed asset cost base – Salvage) / Estimated usable life
Example: Let’s say you purchased a brand new computer, a monitor, and a desk for your office. Below is a summary of the cost basis (including sales tax, shipping, installation & any other costs), the salvage amount and the useful life taken from the IRS table.
Depreciation expenditure per year =
(Fixed asset cost base – Salvage) / Estimated usable life
Calculating Annual Depreciation Expenses on a Computer:
Per year, ($1200 – $200) / 5 = $200
Calculation of Annual Depreciation Expenses:
$60 per year ($300 – ($300 – $0) / 5 = $60 per year) / 5
Calculation of Annual Depreciation Expenses at a Desk:
$100 each year ($1000 – $300) / 7
What are the Benefits and Drawbacks of Applying Straight Line Depreciation?
The following are some of the benefits of employing straight line depreciation:
- It may be used to determine a tax deduction for intangible assets such as patents and copyrights for tax reasons.
- It may also be used for accounting reasons to record depreciation.
- Calculating it is a piece of cake.
The following are some of the drawbacks of employing straight line depreciation:
- Straight line depreciation posits that the value of an asset decreases in a predictable manner during its useful life. Most assets, on the other hand, lose a larger amount of their usable life in the early years. Cars and computers, for example, lose their worth in the first few years. Check out the twofold falling balance and the total of the years digits. Both of these types of depreciation enable you to write off a bigger amount of depreciation in the early years and a lesser amount in the latter years.
For tax purposes, how do you report straight line depreciation?
Intangible assets such as patents and copyrights may benefit from straight line depreciation as a tax credit. Form 4562 must be completed to calculate the amount of depreciation expenditure that is tax deductible. As previously mentioned, the amount you may deduct on your taxes may vary from the amount you can expense on your books.
For accounting purposes, how do you record straight line depreciation?
Depreciation expenditure should be recorded on a monthly basis to keep your profit and loss statement and balance sheet report current. On your profit and loss statement, depreciation charge will raise overall expenses. The cumulative depreciation account will appear on your balance sheet. The entire value of your fixed assets will be reduced by the cumulative depreciation account. A journal entry will be used to record the depreciation charge.
You can quickly create a journal entry in QuickBooks Online to capture depreciation expenditure. Create a journal entry to debit and credit the following accounts to record depreciation expenditure for the computer example above:
You must maintain all receipts, titles, and contracts that demonstrate the date of purchase, your name as the stated owner, and the amount you paid for each item, just as you must record most business costs. This contains receipts for all sums used to determine the asset’s cost basis (such as installation, sales tax, shipment, and so on).
Last but not least, a depreciation plan will be required. You can quickly design a depreciation schedule if you use QuickBooks. We’ll teach you how to accomplish that in the Can QuickBooks Help Me Keep Track of Depreciation section. If you don’t have QuickBooks, you’ll need to use a spreadsheet application like Excel to generate a depreciation plan. Schedules based on useful life are easy to set up. Here’s an example of how I’d create a timetable for fixed assets with a 5-year useful life:
5-Year Property Depreciation Schedule
Is QuickBooks able to assist me in keeping track of depreciation?
QuickBooks is the accounting software that we suggest for small companies. It will not, however, compute depreciation cost for you. You may, however, acquire fixed asset software that will assist you in tracking and calculating depreciation for all of your fixed assets.
You can keep track of all of your fixed asset acquisitions using QuickBooks by adding them to the chart of accounts list. You may run a chart of accounts report and export it to Excel to get the majority of the information you need to generate the depreciation plan we spoke about previously in this post.
You’ll need to set up fixed assets on the chart of accounts in QuickBooks to keep track of them. Watch our How to Set Up the Chart of Accounts video guide to learn more about how to set up fixed assets in QuickBooks. The following is a snapshot of the information needed to create a new fixed account in QuickBooks:
- Fixed Assets is a category type.
- Select the kind of fixed asset from the drop-down menu (i.e. Vehicles).
- Type the name of the fixed asset here.
- In this box, you may provide the same information as in the name field or any extra information about the permanent asset.
- Original price/as of today’s date: The asset’s original cost and date of acquisition should be placed here.
- Depreciation/as of date: Any depreciation that has already been taken.
- Tip: If you began depreciating the asset before putting it up in QuickBooks, you’ll just need to fill in one area.
You may run a chart of accounts report and filter it to display just fixed assets once you’ve established the fixed asset in QuickBooks. The following is a screenshot of the Chart of Accounts with just fixed assets:
You may save this report by exporting it to Excel and adding the extra information that we covered previously that should be included on your depreciation schedules.
If you’re looking for new accounting software for your small company, we suggest QuickBooks. We’ve prepared a free QuickBooks Online training to assist you in quickly setting up and managing your books. There are videos and step-by-step instructions to teach you how to do it! You may access our course right now by clicking here.
Final Thoughts
I hope you now have a better knowledge of how to calculate straight line depreciation, how it affects your financial statements, and some of the benefits and drawbacks of doing so.
Do you have any other questions? Please submit your question in the box below.
Straight line depreciation is a method of depreciating an asset over its useful life. It is calculated by dividing the cost of the asset by its salvage value at the end of its useful life. Reference: straight line depreciation formula excel.
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