Straight-line depreciation is an accounting tool used to spread the cost of a capital asset evenly over its useful life. It’s used for tax and accounting purposes and is the most common type of asset depreciation used by businesses.
Put simply, straight-line depreciation allocates one-third of the total cost of the asset to each accounting period (such as a fiscal year). This allows businesses to write off a portion of the asset cost each period, rather than having to face a large write-off all at once.
How Straight-Line Depreciation Works
A business purchases an asset, such as a computer. It determines that the asset has a total depreciable cost of $3,000, and an estimated useful life of three years. Under straight-line depreciation, the business would allocate $1,000 of the asset cost to each year (the total depreciable cost over the three year useful life).
The business would be able to claim a tax deduction of $1,000 each year for the three years the asset is in use. This allows the business to write off a portion of the asset’s cost over its period of use, rather than having to wait until the end of the useful life and write off all of the cost at once.
Modern Examples of Straight-Line Depreciation
Today, straight-line depreciation is used for a variety of assets. For example, a business may use straight-line depreciation for equipment it uses in production, such as a truck for delivery, machinery for assembly, or a computer for office use. Additionally, business owners may use straight-line depreciation for intangible assets, such as patents, copyrights, and customer lists.
In addition to helping businesses manage taxes and depreciation, straight-line depreciation is also used to help businesses estimate cash flow. This is because by using straight-line depreciation a business can plan ahead for future deductions, and ensure that they have enough cash flow to pay for those deductions.
Conclusion
Straight-line depreciation is a useful accounting tool that allows businesses to spread the cost of a capital asset evenly over its useful life. By allowing businesses to write off a portion of the asset cost each period, straight-line depreciation can help businesses manage their taxes and cash flow more effectively.