Definition: Straight-line depreciation is a method of allocating costs to fixed assets equally throughout their useful lives. In other words, this is the process of recording the expenses associated with a capitalized asset less its salvage value equally over several accounting periods.
What Does Straight Line Depreciation Mean?
Many people get the process of depreciating an asset confused with expensing an asset. Remember fixed assets like furniture, fixtures, equipment, buildings, and vehicles have a useful life of more than one accounting period. According to the matching principle, we must match the expenses with revenues in the time they are incurred.
Since a company benefits from a building for multiple years, it wouldn’t make sense to expense the asset in a single year. Instead, we allocate the cost of the building over the total number of periods it will be used. This process is called depreciation. The building always remains on the balance sheet and is never expensed.
The straight line depreciation method is the simplest form of depreciation because it allocates an equal amount of costs for each accounting period in the asset’s useful life. The straight line depreciation formula is computed by dividing the total asset cost less the salvage value by the number of periods in the asset’s useful life. This amount will be recorded as an expense each year on the income statement.
Let’s take a look at an example.
Don’s Cable Car Company is a trolley car transportation business in the San Francisco area. Don has several trolley cars and just purchased a building for $100,000 to warehouse them during the off-season. Don believes the building will last for 25 years and could probably be sold for $50,000 at the end of it’s useful life.
Using the straight-line depreciation equation, Don calculates his depreciation expense of $2,000 per year ( $100,000 – $50,000 / 25 years ). Each year Don would record this journal entry by debiting depreciation expense for $2,000 and crediting accumulated depreciation for the same amount.