Linear depreciation

Depreciation

Depreciation is the fall in the value of a fixed asset (machine, vehicle, furniture) because of use, wear and tear, passage of time or becoming outdated. It is spread over the asset's working life as an expense.

Key terms:

• Cost of the asset: purchase price plus costs needed to make it ready for use (freight, installation).
• Useful life: the number of years the asset is expected to be used.
• Residual (scrap or salvage) value: the expected value at the end of the useful life.
• Book value: cost minus the total depreciation charged so far.

Linear (straight-line) method

Under the linear method, the same amount is charged every year: Annual depreciation = (Cost − Residual value)/Useful life. The book value falls by equal amounts and, plotted against time, gives a straight line, hence the name. Book value after t years = Cost − t × annual depreciation. Rate of depreciation (as a percentage of cost) = annual depreciation/cost × 100.

Examples

• Cost ₹50,000, residual value ₹5,000, life 9 years: annual depreciation = 45,000/9 = ₹5,000. Book value after 3 years = ₹35,000. Rate = 5,000/50,000 = 10%.
• Cost ₹1,20,000, residual value ₹20,000, annual depreciation ₹12,500: life = 1,00,000/12,500 = 8 years.
• A machine costs ₹80,000 plus ₹5,000 installation, residual value ₹5,000, life 10 years: cost = ₹85,000, annual depreciation = 8,000, and book value after 6 years = 85,000 − 48,000 = ₹37,000.

Key points

• Equal depreciation every year under the linear method.
• Installation and freight are added to the cost.
• Book value at the end of the life equals the residual value.
• The method is simple but ignores the fact that assets may lose value faster when new.

Common mistakes

• Forgetting to subtract the residual value before dividing by the life.
• Leaving installation charges out of the cost.