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Straight-line Method

5 August, 2015 - 14:41

The Straight-line Method reduces the Net-Book value of an asset by the same amount each period. This amount is determined by dividing the total value of said asset by some number of periods, then subtracted from the balance at the end of each period.

For example,if you purchased a sewing machine for $12,000 and you wrote it off over 12 months using the Straight-line method, you would divide the original cost ($12,000) by the term of useful life (12 months). In this case, $12,000 / 12 months = $1,000/month. To apply depreciation on this item, you would deduct $1,000 at the end of the first month to leave a balance of $11,000. The second month you would deduct another $1,000 leaving a balance of $10,000. At the end of the 12th month, you would deduct the last $1,000 from the previous (11th months) balance of $1,000, leaving you with a balance of $0.

At this point you would say that you have written off the sewing machine. In practice, things get a little more complicated. In this example it would not be fair to assume that at the end of the 12th month the machine would suddenly stop working, or be absolutely worthless, though for tax purposes it is considered to have zero basis. It is possible you could still sell the completely written off sewing machine for $1,000, causing you to recognize a $1,000 taxable gain.

The economic reasoning behind the Straight-line method is, essentially, the acceptance that depreciation is an approximation of the rate at which an asset transfers value to the Operations of a business by participating productively in it, and so we should use the most economical one (regarding computational effort) to calculate and record it in the accounting books. There are certain Intangible Assets for which the Straight-Line method can be considered the relatively more accurate one. But for most Tangible Assets there is good argument that the Declining Balance method is more suitable (see below). Nevertheless, the simplicity of the Straight-line method had made it the prevailing one, accepted by economists, accountants, analysts, businesses, and even state authorities (for tax purposes).