Straight line depreciation is perhaps the most basic way of calculating the loss of value of an asset over a period of time. We calculate yearly depreciation by averaging the difference between the purchase price of an asset at the beginning of its useful life and the salvage value of the asset at the end of its useful life over the useful life of the asset. The formula is shown below:
- Purchase Price = value of the asset at the beginning of its useful life
- Salvage Value = value of the asset at the end of its useful life
- Useful Life = expected number of useful periods
Here, we are simply taking an average of the useful value of the asset over its useful life. The useful life can be of any frequency, be it years, quarters, months, etc., but remember then that the depreciation value will be the value per period.
Suppose you buy a new piece of machinery that costs $12,000, and you believe that you can use the machine for five years with an anticipated sale value of $2,000. How much will the machine depreciate each year?
We can simply plug our values in and solve directly, with a purchase price of $12,000, a salvage value of $2,000, and a useful life of five years. The work is shown below:
So, the machine will depreciate in value each year by $2,000.