The simplest and most commonly used depreciation method, straight line depreciation is calculated by taking the purchase or acquisition price of an asset subtracted by the salvage value divided by the total productive years the asset can be reasonably expected to benefit the company (called "useful life" in accounting jargon).
Straight Line Depreciation Calculation
(Purchase Price of Asset - Approximate Salvage Value) ÷ Estimated Useful Life of Asset
Example: You buy a new computer for your business costing approximately $5,000. You expect a salvage value of $200 selling parts when you dispose of it. Accounting rules allow a maximum useful life of five years for computers. In the past, your business has upgraded its hardware every three years, so you think this is a more realistic estimate of useful life, since you are apt to dispose of the computer at that time. Using that information, you would plug it into the formula:
($5,000 purchase price - $200 approximate salvage value) ÷ 3 years estimated useful life
The answer, $1,600, is the depreciation charges your business would take annually if you were using the straight line method.
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This page is part of Investing Lesson 4 - How to Read an Income Statement. To go back to the beginning, see the Table of Contents.
