Straight line method/ Fixed instalment method / Original cost method
Under this method, a fixed percentage on the original cost of the asset is charged every year by way of depreciation. Hence it is called original cost method. As the amount of depreciation remains equal in all years over the useful life of an asset it is also called as fixed instalment method. When the amount of depreciation charged over its life is plotted on a graph and the points are joined together, the graph will show a horizontal straight line. Hence, it is called straight line method.
This method is suitable for those assets the useful life of which can be estimated accurately and which do not require much expense on repairs and renewals.
Under this method, the following formulae are used for calculating the amount of depreciation and the rate of depreciation respectively:
· In the year of purchase, if the period of use is less than a year, the amount of depreciation will be charged proportionately for the period for which the asset has been used in the business.
· If depreciation is deducted from the cost of the asset at the end of useful life of the asset the amount left in the asset account will be equal to the scrap value if there is any scrap value or it will be zero if there is no scrap value.
On 1.1.2012, a firm purchased a machine at a cost of Rs. 1,10,000. Its life was estimated to be 10 years with a scrap value of Rs. 10,000. The amount of depreciation to be charged at the end of each year is:
When it is plotted on a graph for 5 years, it appears as follows:
Following are the merits of straight line method of depreciation:
Computation of depreciation under this method is very simple and is easy to understand.
Under this method, equal amount of depreciation is debited to the profit and loss account each year. Hence, the burden of depreciation on the profit of each year is equal..
Under this method, the book value of an asset can be reduced to zero if there is no scrap value or to the scrap value at the end of its useful life. Thus the asset account can be completely written off.
This method is appropriate for the fixed assets having certain fixed period of working life. In such cases, the estimation of useful life is easy and in turn it helps in easy determination of rate of depreciation.
Following are the limitations of straight line method of depreciation:
Under this method, a fixed amount of depreciation is provided on each asset by applying the predetermined rate of depreciation on its original cost. But, the actual use of the asset is not considered in computation of depreciation.
This method does not take into account the loss of interest on the amount invested in the asset. That is, the amount would have earned interest, had it been invested outside the business is not considered.
With the passage of time, the cost of maintenance of an asset goes up. Hence, the amount of depreciation and cost of maintenance put together is less in the initial period and goes up year after year. But, this method does not consider this.
It may be quite difficult to assess the true scrap value of the asset after a long period say 10 or 15 years after the date of its installation.
Straight line method of depreciation is suitable in case of fixed assets in respect of which useful life can be determined and maintenance and repair cost is the same throughout the life of the asset.
On 1.1.2017 a firm purchased a machine at a cost of Rs. 1,00,000. Its life was estimated to be 10 years with a scrap value of Rs. 10,000. Compute the amount of depreciation to be charged at the end of each year.
A company has purchased a machinery for Rs. 1,80,000 and spent Rs. 10,000 for its installation. The estimated life of the machinery is 5 years with a residual value of Rs. 15,000. Find out the amount of depreciation to be provided every year.
From the following information, calculate the amount of depreciation and rate of depreciation under straight line method.
Purchase price of machine Rs. 2,00,000
Expenses to be capitalised Rs. 50,000
Estimated residual value Rs. 15,000
Expected useful life 5 years
Find out the rate of depreciation under straight line method from the following details:
Original cost of the asset = Rs. 10,000
Estimated life of the asset = 10 years
Estimated scrap value at the end = Rs. 2,000