What is Straight Line Basis?
Straight line basis is a method of calculating depreciation and amortization. Also known as straight line depreciation, it is the simplest way to work out the loss of value of an asset over time. 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.
Understanding Straight Line Basis
In accounting, there are many different conventions designed to better match sales and expenses to the period in which they are incurred. One convention that companies embrace is referred to as depreciation or amortization.
Companies use depreciation for physical assets, and amortization for intangible assets such as patents and software. Both are conventions that are used to expense an asset over a longer period of time, not just in the period that it was purchased. In other words, companies can stretch the cost of assets over many different periods, enabling them to benefit from the asset without deducting the full cost from net income (NI).
The challenge is determining how much to expense. One method accountants use to determine this amount is referred to as the straight line basis method.
To calculate the straight line basis, company’s 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. The resulting figure is then divided 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
- Straight line basis is a method of calculating depreciation and amortization, the process of expensing an asset over a longer period of time.
- 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.
Example of Straight Line Basis
Let's assume 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 must divide the difference between the salvage value and the cost of the equipment, also referred to as the depreciable base or asset cost, with 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 has 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 only uses three different variables to calculate the amount of depreciation each accounting period.
The straight line basis’ simplicity 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.