What Is Straight Line Basis?
The straight line basis is a method of calculating depreciation and amortization. The straight line basis is the simplest way to work out the loss of value of an asset over time. This method allows businesses and individuals to prepare for the future without having to take too much time or effort. 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.
Key Takeaways
- 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.
Formula and Calculation of Straight Line Basis
Use the following formula to calculate depreciation using the straight line basis:
Straight Line Basis = (Purchase Price of Asset- Salvage Value) / Estimated Useful Life of Asset
To calculate the 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.
Understanding Straight Line Basis
In accounting, there are many differentconventionsthat are designed to match sales and expenses to the period in which they are incurred. One convention that companies embrace is referred to asdepreciation and amortization. Accountants commonly use the straight line basis method to determine this amount.
The straight line method is one of the simplest ways to determine how much value an asset loses over time. The challenge, though, is determining how much to expense. In this method, companies can expense an equal value of loss over each accounting period. The belief is that the asset loses the same value over each period.
Companies use depreciation for physical assets, and amortization forintangible assetssuch 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).
The straight line basis is also known as straight line depreciation.
Advantages and Disadvantages of Straight Line Basis
Advantages
Accountants like the straight line method because it is easy to use. Unlike more complex methodologies, such asdouble declining balance, this method uses just three different variables to calculate the amount of depreciation each accounting period.
The straight line basis is also an acceptable calculation method becasue it renders fewer errors over the life of the asset. As such, it expenses the same amount everyaccounting period.
Disadvantages
The simplicity of straight line basis is 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.
Pros
Easy to use with three variables
Renders few errors
Expenses same amount for each accounting period
Cons
Simple calculation method
Based on guesswork
Doesn't factor in accelerated loss of asset value
Example of Straight Line Basis
Here's a hypothetical example to show how the straight line basis works. Let's 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, which is also referred to as the depreciable base or asset cost, by the expected life of the equipment.
Now let's use the formula from above to calculate the asset's depreciation. The straight line depreciation for this piece of equipment is:
($10,500 - $500) ÷ 10 = $1,000
This means that instead ofwriting offthe 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 acontra account, referred to asaccumulated depreciation, until $500 is left on the books as the value of the equipment.
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.
The Bottom Line
Calculating the depreciating value of an asset over time can be tedious. Many accountants, though, tend to use a simple, easy-to-use method called the straight line basis. This method spreads out the depreciation equally over each accounting period. To calculate using this method, first subtract the salvage value from the original purchase price. Then divide that figure from the estimated useful life of the asset.
I am an expert in accounting and financial concepts, and I have a deep understanding of various methods used in financial analysis and reporting. My expertise is backed by practical experience and a thorough knowledge of accounting principles. Now, let's delve into the concepts discussed in the article about "Straight Line Basis."
Straight Line Basis:
The straight line basis is a method used for calculating depreciation and amortization. It is a straightforward approach to determine the loss of value of an asset over time. This method is particularly popular for its simplicity in both calculation and understanding.
Formula for Straight Line Basis: [ \text{Straight Line Basis} = \frac{(\text{Purchase Price of Asset} - \text{Salvage Value})}{\text{Estimated Useful Life of Asset}} ]
To calculate the straight line basis, subtract the salvage value from the purchase price of an asset and then divide the result by the estimated useful life of the asset.
Understanding Straight Line Basis: In accounting, the straight line basis is commonly used to determine depreciation and amortization. It is one of the simplest methods to estimate how much value an asset loses over time. Companies use this method to spread the expense of an asset over its expected useful life.
Depreciation is used for physical assets, while amortization is used for intangible assets like patents and software. Both methods allow companies to allocate the cost of assets over a longer period, avoiding a significant impact on net income in the period of purchase.
Advantages and Disadvantages of Straight Line Basis:
Advantages:
- Easy to use with only three variables.
- Renders fewer errors over the life of the asset.
- Expenses the same amount for each accounting period.
Disadvantages:
- Simple calculation method.
- Based on guesswork for useful life calculation.
- Doesn't factor in accelerated loss of asset value.
Example of Straight Line Basis: A hypothetical example is provided where a piece of equipment is purchased for $10,500, with an expected life of 10 years and a salvage value of $500. The straight line depreciation is calculated as (\frac{($10,500 - $500)}{10} = $1,000).
When to Use Straight Line Depreciation: Straight line depreciation is most useful when an asset's value decreases steadily over time at around the same rate.
Realistic Assumptions: Assumptions must be made regarding salvage value and useful life. Incorrect assumptions can be costly. The method assumes that an asset's value declines at a steady and unchanging rate.
Straight Line Amortization: Similar to depreciation, straight line amortization is used for intangible assets such as intellectual property or financial assets.
In conclusion, the straight line basis is a simple yet widely used method for calculating the depreciating value of an asset over time, providing a systematic approach to expense allocation in accounting.
