It first calculates the depreciable base (cost less salvage) before dividing it by number of years (life of machine) to arrive at annual rate of depreciation. The straight-line method is the most straightforward method of Asset Value Depreciation. But:
§ Not all equipment deteriorates equally e.g. a car, over its useful life.
§ Methods based on actual usage: total life are too cumbersome to be practicable
For Example: Say a machine costs Rs. 10,000 and Rs. 1,000 (as additional set-up/installation/maintenance expenses) = Rs 11,000 but we anticipate/guess its Kabari (Scrap Value) at Rs. 3,000 at the end of its useful life, of say, 10 yrs,
Cost of Machine + Installation + Directly Associated Costs = Total Cost
Total Cost - Salvage Value (At end of 10 yr. Period) = Depreciable base
10,000 + 1,000 =11000 (Total cost)
11000 – 3,000 = 8,000 as the Depreciable Base
Depreciable Base = Rs. 8,000, Spread out over
10 yrs = Rs. 8000/10(Yrs) = Rs 800/- depreciation per year.
This happens when we accurately assess asset life, but:
- If the machine outlasts its estimated life, we stop depreciation thereafter. If it fetches more salvage value, we book a Gain. If salvage value is 5000, against 3000 (Book Value at end of 10 yrs), we show a Gain of Rs. 2000. If the machine becomes obsolete after a mere 3 years, depreciation is 3(yrs) x 800 (p.a.) = 2400/-, less scrap value Rs. 500/-, we have a net loss of
11,000 – 2400 = Rs. 8600 (book value) – 500 (salvage returns) = Rs 8,100 (loss).
Cost = 11000
Annual Depreciation = 800 x 3= 2400 = 8600 (Book value)
(Book value) 8600 – 500 (salvage value) = 8100 (Net loss)
Proportionate Annual Depreciation of Rs. 800 (8000 ё 10) is an example of the Straight Line Method of Depreciation.