What straight-line depreciation actually measures
Straight-line depreciation allocates the cost of a long-lived asset evenly across the periods that use it. It is a cost-allocation exercise, not a valuation exercise: nothing in the calculation estimates what the asset is worth today, and no cash moves when you post the entry.
The reason to bother is matching. A $25,000 machine that runs for five years helps earn revenue in all five, so charging the whole $25,000 against the first year would understate that year's profit and overstate the next four. Depreciation splits the cost so each period carries the share of the asset it consumed. Straight-line makes the simplest defensible assumption about that consumption — that it is constant — which is why it is the method FASB ASC 360 and IAS 16 accept without further argument, and why an auditor will want a specific reason before you use anything else.
Two consequences catch people out. First, net book value is the residue of an arithmetic schedule, not a market price: a five-year-old truck may well sell for more than its carrying amount, or for much less, and neither outcome means the schedule was wrong. Second, depreciation is a non-cash expense, which is why it is added straight back at the top of the cash flow statement built by the indirect method. It lowers reported profit and taxable income without touching the bank balance.
The three numbers the formula needs
Cost is the full capitalised amount, not the invoice price. ASC 360 and IAS 16 both capitalise everything necessary to get the asset ready for its intended use: purchase price net of trade discounts, freight-in, duties, non-refundable taxes, rigging, site preparation and initial testing. You do not capitalise operator training, financing charges on an ordinary purchase, or the first service. An error here repeats in every year of the schedule.
Salvage value — residual value under IFRS — is what you expect to recover when you are finished with the asset, net of the cost of disposing of it. It does not have to be zero, and it has nothing to do with the tax rules, which ignore salvage entirely. IAS 16 requires you to review residual value and useful life at least annually; US GAAP requires review when events indicate the estimate has changed.
Useful life is how long the asset will serve you: your shift pattern, your maintenance policy, your replacement cycle, and the point where obsolescence makes keeping it pointless. A press with a 30-year physical life on a seven-year replacement policy has a seven-year useful life.
Subtract salvage from cost and you have the depreciable base, the amount that will pass through the income statement over the asset's life. Divide by the life and you have the annual charge. Ledgers often quote the same thing as a rate: a five-year life is "20% straight line", because 1 ÷ 5 = 20% of the base each year. When the asset enters service part-way through your fiscal year you charge only the months it served, which pushes a matching stub of depreciation into one extra fiscal year at the end.
Worked example: a $25,000 lathe placed in service on 1 April
You buy a CNC lathe for $23,800, pay $900 freight and $300 for rigging and levelling, so the capitalised cost is $25,000. You expect to sell it for about $2,500 after five years, and it goes into service on 1 April, which leaves nine months of a calendar fiscal year.
- Depreciable base. $25,000 − $2,500 = $22,500.
- Annual expense. $22,500 ÷ 5 = $4,500 for a full year.
- Monthly expense. $4,500 ÷ 12 = $375.
- Year 1, nine months. $375 × 9 = $3,375.
- Net book value at the end of year 1. $25,000 − $3,375 = $21,625.
- Years 2 to 5. $4,500 each. Accumulated depreciation reaches $3,375 + $18,000 = $21,375 and book value falls to $3,625.
- Year 6 stub. The three months left over: $375 × 3 = $1,125. Accumulated depreciation is now $22,500 — exactly the depreciable base — and book value equals the $2,500 salvage estimate.
Each year you debit Depreciation expense and credit Accumulated depreciation — machinery; in year 1 that is $3,375 on both sides. Note that a nine-month start makes a five-year asset span six fiscal years. At a 21% marginal rate, a full year of this deduction defers $4,500 × 0.21 = $945 of tax, the figure the depreciation tax shield calculator works with.
How to read the schedule
Read net book value as "cost not yet expensed", never as "what this is worth". Then test the estimate against reality: if the asset's resale price at year three is nowhere near its carrying amount, your life or salvage figure is wrong, and the fix is a prospective change in estimate — spread the remaining book value less salvage over the remaining life from that point forward under ASC 250 or IAS 8.
Depreciation stops at salvage. You do not depreciate below the residual estimate, and a fully depreciated asset stays on the books at that amount until you dispose of it. If assets in daily use are routinely fully depreciated, your useful lives are too short and current profit is flattered. A collapse in value for a specific reason — fire, obsolescence, a lost contract — is impairment, tested separately under ASC 360-10-35 or IAS 36, and adjusting depreciation is not the remedy.
Analysts read the schedule in aggregate. Annual depreciation divided by gross property, plant and equipment implies an average life for the whole asset base: 10% implies roughly ten years, and an implied life that keeps stretching is a way of pushing earnings forward. For a manufacturer, depreciation on factory assets is product cost, so it lands in inventory and then in cost of goods sold rather than operating expense. It also sits in the denominator of return on assets and asset turnover, which is why two otherwise identical businesses with different depreciation policies do not screen alike.
Straight-line rate and expense per $1,000 of depreciable base
| Useful life | Annual rate | Annual expense per $1,000 | Monthly expense per $1,000 |
|---|---|---|---|
| 3 years | 33.333% | $333.33 | $27.78 |
| 5 years | 20.000% | $200.00 | $16.67 |
| 7 years | 14.286% | $142.86 | $11.90 |
| 10 years | 10.000% | $100.00 | $8.33 |
| 15 years | 6.667% | $66.67 | $5.56 |
| 20 years | 5.000% | $50.00 | $4.17 |
| 27.5 years | 3.636% | $36.36 | $3.03 |
| 39 years | 2.564% | $25.64 | $2.14 |
27.5 and 39 years are the straight-line recovery periods US tax law assigns to residential rental and non-residential real property. The shorter lives are common book lives for computers, vehicles, equipment and fixtures.
Mistakes that put a depreciation schedule out
- Expensing costs that belong in the asset. Freight, rigging, installation and initial testing are part of cost under ASC 360 and IAS 16. Expensing them understates the asset and overstates this year's costs.
- Setting salvage to zero because it is easier. Tax depreciation ignores salvage; book depreciation does not. A zero residual on a truck you always sell at year three overstates expense every year and then produces an artificial gain on disposal.
- Using the tax life for the books. A five-year MACRS class life is a tax convention, not an estimate of service life. Keep two schedules.
- Depreciating land. Land is never depreciated. Land improvements with a finite life — paving, fencing, lighting — are.
- Starting the clock on the invoice date. Depreciation begins when the asset is available for its intended use, which may be weeks after delivery and payment.
- Restating prior years after revising an estimate. A new life or residual is a change in estimate applied prospectively (ASC 250, IAS 8), not an error correction.
- Running past salvage. The schedule must stop when accumulated depreciation equals cost less salvage, whatever the calendar says.
- Ignoring components. IAS 16 requires separate depreciation of significant parts with different lives — an aircraft's engines and airframe, a building's roof and shell. US GAAP permits it but does not require it.
When another method fits the asset better
Straight-line is right when an asset delivers roughly equal service each year: buildings, furniture, fixtures, most software. Three alternatives fit other patterns of use.
Declining balance charges a fixed percentage of falling book value, so the expense is front-loaded. It suits assets that are most productive when new and expensive to keep when old, and it tracks the value curve of vehicles and IT equipment. Compare the double declining balance calculator and the gentler sum-of-the-years-digits calculator against this one on the same asset.
Units of production ties the charge to output, hours or miles — presses, mining equipment, aircraft engines — and is the only common method that records nothing in an idle year.
MACRS is not a choice: US tax law prescribes it for most assets placed in service after 1986, with fixed class lives, a half-year or mid-quarter convention and no salvage value. Keep it on a separate schedule from your book numbers — the MACRS depreciation calculator handles the percentage tables — because the gap between the two schedules is what creates deferred tax.
Which standard governs this
The measurement rules are FASB ASC 360, Property, Plant, and Equipment, under US GAAP and IAS 16, Property, Plant and Equipment, under IFRS. Both require a systematic allocation of the depreciable amount over the useful life, and both define that amount as cost less residual value. Neither mandates straight-line: they require a method reflecting the pattern in which the asset's benefits are consumed, and straight-line is what survives when you have no evidence of an uneven pattern. US tax depreciation follows IRC §168 and IRS Publication 946 instead, and will not match your book schedule.
Key terms
- Capitalised cost
- The amount recorded as the asset: purchase price plus all costs of bringing it to the location and condition needed for its intended use.
- Depreciable base
- Cost less salvage value — the total amount that will be charged to expense across the asset's life.
- Salvage (residual) value
- The amount you expect to recover on disposal at the end of the useful life, net of costs of disposal.
- Useful life
- The period over which the asset is expected to be available for use by your business, which is usually shorter than its physical life.
- Accumulated depreciation
- A contra-asset account holding the total depreciation charged on an asset since it entered service.
- Net book value (carrying amount)
- Cost less accumulated depreciation, less any impairment. An accounting residue, not a market value.