Straight-Line Depreciation

The calculation runs in two steps. First, subtract estimated residual value from capitalised cost to obtain the depreciable base; capitalised cost includes purchase price plus all expenditures required to bring the asset to working condition, such as delivery, installation and testing. Second, divide that base by the estimated useful life in years to get the constant annual charge. Expressed as a rate, the charge equals the depreciable base multiplied by one divided by useful life.

Carrying amount at any date equals cost minus accumulated depreciation, so the book value declines by an identical amount each year and converges on residual value at the end of the service life. Depreciation stops at that floor even if the asset remains in use. Assets acquired mid-year are charged only for the months held, so the first and final fiscal years each carry a partial charge, and candidates should read the acquisition date carefully before annualising.

The property, plant and equipment note discloses the method, useful-life ranges by asset class and the split between gross cost and accumulated depreciation. Under IFRS, significant components with different service lives must be depreciated separately, so an aircraft airframe, engines and cabin interior can each carry their own straight-line schedule; US GAAP permits but rarely requires this granularity. Residual values and lives are reviewed at least annually under IFRS.

Because depreciation is non-cash, it is added back to net income in the operating section under the indirect method and never touches cash flow. It does, however, drive deferred taxes: most jurisdictions require accelerated cost recovery for tax purposes, so a firm reporting straight-line for financial statements records lower depreciation on the books than on the return in early years, producing a deferred tax liability that reverses as the asset ages.

Useful life and residual value are accounting estimates, not policies. A revision is applied prospectively: the remaining carrying amount less the revised residual value is spread over the revised remaining life, with no restatement of prior periods. Lengthening lives therefore lowers future expense and lifts reported earnings without any change in economics, which is why analysts monitor disclosed life ranges over time and against peers.

Three approximations built on straight-line logic are standard. Average depreciable life is gross PP&E divided by annual depreciation expense. Average age is accumulated depreciation divided by annual depreciation expense, and remaining life is net PP&E divided by annual depreciation expense. These hold only loosely when asset mix is heterogeneous or growth is rapid, but they flag an ageing asset base and impending capital expenditure needs.

Expect to compute the annual charge and the carrying amount at a stated date, including partial first years, and to rebuild a schedule after a change in estimate. Expect comparisons: against double-declining balance, which ignores residual value in the annual computation but stops at it, and against units-of-production, which ties expense to output rather than time.

The higher-value skill is directional reasoning. Relative to accelerated methods, straight-line raises early net income, equity and total assets, and therefore early return on assets, return on equity and net profit margin, while depressing asset turnover; the ordering reverses in later years. Total expense over the asset's life is identical under every method, and cash flow before tax effects is unaffected. When comparing two firms, adjusting one to a common depreciation assumption is often the only way to make margins and asset bases genuinely comparable.