Straight-Line Depreciation

Straight-line depreciation is the simplest depreciation method because it assumes assets lose value evenly throughout their lives. The annual depreciation rate is 100% divided by the useful life; for example, a five-year useful life asset has an annual depreciation rate of 100%/5 = 20%. The annual depreciation expense is the depreciation rate times the depreciable cost.

A five-year asset purchased for $100,000 with an expected residual value of $10,000 has an annual depreciation expense of 0.2x ($100,000 – $10,000) = $18,000. After each year, the depreciation expense reduces the depreciable basis (for example, after the first year, the depreciable basis is

Accelerated Depreciation

Compared to straight-line depreciation, accelerated depreciation methods make the more reasonable assumption that an asset loses more of its value early in its life. Different methods of calculating accelerated depreciation exist, but the most common is the declining-balance method. The declining-balance method doubles the depreciation rate suggested by the straight-line method and multiplies this rate by the asset's remaining depreciable cost. The depreciable cost equals the purchase cost and is not adjusted by the residual value, though you cannot depreciate an asset below its residual value.

For the asset described above, the first year's depreciationexpense is 0.2 x 2 x $100,000 = $40,000, and the remainingdepreciable basis is $100,000 - $40,000 = $60,000. Therefore, thesecond year's depreciation expense is andthe remaining depreciable basis is Becauseyou cannot depreciate an asset below its residual value, if ayear's calculated depreciation expense makes the depreciable basisless than the residual value, you ignore the calculated value andmake the result equal the residual value.

Check Your Understanding

A company has purchased a new machine for $7,500, and the machine is expected to have a residual value of $1,500 at the end of its six-year life.

Calculate the machine's depreciation using the straight-line method:

	Depreciable cost = $6,000
	Annual depreciation expense = $1,000

Calculate the machine's depreciation using the declining balance method:

	Depreciable cost = $7,500
	Year 1 depreciation expense = $2,500
	Year 2 depreciation expense = $1,667

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