Straight-Line Depreciation

Straight-Line Depreciation The simplest form of depreciation is straight-line depreciation. Straight-line depreciation spreads the cost of an asset evenly over its useful life. The formula for straight-line depreciation introduced in Chapter is: The original cost of the asset less its estimated residual value is referred to as the depreciation base of the asset. For the equipment described above, the depreciation base is $4,500 ($5,000 - $500). The useful life is five years; therefore, the depreciation expense for each year is $900 ($4,500/5). At the end of the first year of ownership, the entry to record depreciation expense is: Depreciation Expense is a temporary income statement account that is closed to Income Summary along with all of the other revenue and expense accounts. Depreciation Expense will appear on the 1993 income statement as an expense, thereby reducing net income. The Accumulated Depreciation account is not closed; it is a contra asset account, and balance sheet accounts are not closed at the end of the accounting period. The Accumulated Depreciation account is shown on the balance sheet as a negative amount deducted from the original cost of the asset with which it is associated. Therefore, the equipment is disclosed on Paul's December 31, 1993, balance sheet as follows: Recall that the difference between the original cost of an asset and the accumulated depreciation ($4,100 in this case) is referred to as the book value of the asset. Thus, the depreciation entry reduces total assets on one side of the accounting equation by lowering the book value of the asset and at the same time reduces owner's equity by increasing total expenses, thereby lowering net income. At the end of the second year of ownership, depreciation will again be recorded as follows: The Depreciation Expense account is closed to the Income Summary account and appears on the 1994 income statement. The equipment is disclosed on Paul Company's December 31, 1994, balance sheet as follows: Note that the Accumulated Depreciation account, as its name im-plies, has accumulated the additional depreciation for the second year, and that the increased accumulated depreciation results in a lower book value for the asset as compared with the amount disclosed at the end of the previous year. The depreciation process for this asset will continue for three more years. At the end of 1995, Depreciation Expense will again be debited for $900 and Accumulated Depreciation credited for $900. This entry increases the balance in the Accumulated Depreciation account to $2,700 and lowers the book value of the asset to $2,300. At the end of 1996, the same entry is made, increasing the Accumulated Depreciation balance to $3,600 and lowering the book value of the asset to $1,400. At the end of 1997, the entry will be made one more time, increasing the Accumulated Depreciation balance to $4,500 and lowering the book value of the asset to $500. At this point, the depreciation process will stop. The asset was originally estimated to have a five-year life and a residual of $500. Assets are not depreciated below their original estimated residual values unless the original estimate has been changed for some reason, and they are never depreciated below their original historical cost. It is possible that the asset will continue in use beyond the end of its original estimated life. As long as the asset continues to be used by the business, it remains on the books but is no longer depre-ciated. Once an asset's book value has been reduced to its original estimated residual value (which may be zero), it is said to be fully depreciated. If it remains in service, the asset will be disclosed on Paul's December 31, 1997, and subsequent years' balance sheets as follows: To avoid repeating the same calculations at the end of each accounting period, most accountants find it useful to prepare a depreciation schedule at the time that each depreciable asset is acquired. The depreciation schedule for the equipment using straight-line depreciation is illustrated in Exhibit