What Is Straight Line Basis?
Straight line basis is calculated by dividing the difference between an asset's cost and its expected salvage value by the number of years it is expected to be used.
- Straight line basis is a method of calculating depreciation and amortization, the process of expensing an asset over a longer period of time than when it was purchased.
- It is calculated by dividing the difference between an asset's cost and its expected salvage value by the number of years it is expected to be used.
- Straight line basis is popular because it is easy to calculate and understand, although it also has several drawbacks.
- Alternatives often involve accelerating depreciation schedules.
Understanding Straight Line Basis
In accounting, there are many different conventions that are designed to match sales and expenses to the period in which they are incurred. One convention that companies embrace is referred to as depreciation and amortization.
Companies use depreciation for physical assets, and amortization for intangible assets such as patents and software. Both conventions are used to expense an asset over a longer period of time, not just in the period it was purchased. In other words, companies can stretch the cost of assets over many different time frames, which lets them benefit from the asset without deducting the full cost from net income (NI).
Calculating Straight Line Basis
The challenge is determining how much to expense. One method accountants use to determine this amount is the straight line basis method.
To calculate straight line basis, take the purchase price of an asset and then subtract the salvage value, its estimated sell-on value when it is no longer expected to be needed. Then divide the resulting figure by the total number of years the asset is expected to be useful, referred to as the useful life in accounting jargon.
Straight Line Basis = (Purchase Price of Asset - Salvage Value) / Estimated Useful Life of Asset
Example of Straight Line Basis
Assume that Company A buys a piece of equipment for $10,500. The equipment has an expected life of 10 years and a salvage value of $500. To calculate straight line depreciation, the accountant divides the difference between the salvage value and the cost of the equipment—also referred to as the depreciable base or asset cost—by the expected life of the equipment.
The straight line depreciation for this piece of equipment is ($10,500 - $500) / 10 = $1,000. This means that instead of writing off the full cost of the equipment in the current period, the company only needs to expense $1,000. The company will continue to expense $1,000 to a contra account, referred to as accumulated depreciation, until $500 is left on the books as the value of the equipment.
Advantages and Disadvantages of Straight Line Basis
Accountants like the straight line method because it is easy to use, renders fewer errors over the life of the asset, and expenses the same amount every accounting period. Unlike more complex methodologies, such as double declining balance, straight line is simple and uses just three different variables to calculate the amount of depreciation each accounting period.
However, the simplicity of straight line basis is also one of its biggest drawbacks. One of the most obvious pitfalls of using this method is that the useful life calculation is based on guesswork. For example, there is always a risk that technological advancements could potentially render the asset obsolete earlier than expected. Moreover, the straight line basis does not factor in the accelerated loss of an asset’s value in the short-term, nor the likelihood that it will cost more to maintain as it gets older.
How Do You Calculate Straight Line Depreciation?
To calculate depreciation using a straight line basis, simply divide net price (purchase price less the salvage price) by the number of useful years of life the asset has.
When Should One Use Straight Line Deprecation?
Straight line is the most straightforward and easiest method for calculating depreciation. It is most useful when an asset's value decreases steadily over time at around the same rate.
What Are Realistic Assumptions in the Straight-Line Method of Depreciation?
While the purchase price of an asset is known, one must make assumptions regarding the salvage value and useful life. These numbers can be arrived at in several ways, but getting them wrong could be costly. Also, a straight line basis assumes that an asset's value declines at a steady and unchanging rate. This may not be true for all assets, in which case a different method should be used.
What Is Straight Line Amortization?
Straight line amortization works just like its depreciation counterpart, but instead of having the value of a physical asset decline, amortization deals with intangible assets such as intellectual property or financial assets.