4. Straight Line Depreciation

Let's look at the straight line method for depreciation. I like straight line because it's easy. It's very straightforward. You've got some amount over some number of years, and you depreciate it on a straight line over that number of years. So if you've got $100,000 in five years, it just goes down at a constant angle. So your slope never changes on a straight line method. Now, I wanna do something to show you how easy it is to figure out the straight line. So if we say we've got $100,000 and you've got two years to get to zero, how much should you do per year?

Well, obviously you should do $50,000 per year, because you've only got two years to get to zero, and you start at 100. So if you do 50 per year, you're gonna get to zero at the end, right? Now, what's the formula that we did in our head to get to 50 and 50? We said 100 over 2, which really, when you abstract it, becomes cost over life. So if we said it's actually five years, it's a five-year useful life, you would do 100 over 5 equals $20,000 per year. So you would do 20, 20 for five years, and you end up at your total.

So again, it just looks like a straight line all the way down until you get to zero. And that's why straight line is so great, because there's really nothing hard about it. Now, I showed you in the last video that if you have a salvage value, you should never depreciate beyond the salvage value. So if we say there's $10,000 of salvage value for this asset, whatever it is, well, we know that we can't just put the cost over the life because if we go back to our super simple example and we say that we need to stop at 10,000, well, then 50 and 50 isn't right anymore.

50 the first year and 50 the second year takes us all the way to zero. But you know, because you're smart, you can never go past salvage value. So if we redraw this example, we say cost is 100, salvage value is 10, and useful life is five years, then you draw it out like this and you say, "Okay, cost is 100, salvage is 10, useful life is five years." Well, how do you go from 100 to 10 over five years? What amounts do you have to recognize per year over five years to get down to 10? Well, that becomes this equation. Well, we know we need to get down to 10, so we have 90 that we're dealing with here, and we have five years to get down to the 10.

So if we put 90 over 5, we get 18. So the true form of the equation is this one. It's cost minus the salvage value over the useful life, and that gives you your per year expense. And if you'll recall, this cost minus the salvage value is something called depreciable base. So this is the amount that we're able to depreciate. So we're gonna take the entire amount that we're able to depreciate, and we're gonna allocate that over the useful life of five years. So we know that in total we're able to depreciate 90, because the acquisition cost was 100, and what we can sell it for at the end of its useful life is 10.

That means we can only depreciate 90. So we're gonna take 90 and say, "Okay, I've got five years to get rid of 90. I can do that by doing 18 per year." Straight line is great because you figure it out once, and then that's what you use for every single year. So straight line evenly allocates the acquisition cost over the useful life by taking the depreciable base, how much you can depreciate, and dividing it by the useful life.