3.6 : Calculating Depreciation: Straight-line Method

Depreciation is an accounting method for allocating the cost of a tangible asset over its useful life. It reflects the gradual decrease in the asset's value as it is used in business operations.

The Straight-Line Method of depreciation assumes an asset loses value evenly over its useful life until it reaches its residual or scrap value. This method is commonly applied to long-term assets such as buildings and vehicles.

The asset's initial cost, estimated useful life, and expected scrap value are required to calculate depreciation. The formula reflects a steady reduction in the asset's value over time.

For example, if Paramount purchases a machine for $50,000 with an estimated useful life of five years and a scrap value of $5,000, the annual depreciation expense would be $9,000. This means the machine's value will decrease by the same amount each year on Paramount's balance sheet over the next five years.

While this method simplifies depreciation calculations, it does not account for fluctuations in usage or increasing repair costs as the asset ages.