18.5.1. Straight Line Method (SLM)

Also known as the Fixed Installment Method. The same amount is charged each year.

Formula: Cost of asset−Residual value Depreciation per year= Useful life

The Straight Line Method (SLM) of depreciation is one of the most straightforward ways to allocate the cost of an asset over its useful life. In SLM, the same amount of depreciation expense is recorded every year until the asset is fully depreciated. The formula used is:

Depreciation per year = (Cost of asset - Residual value) / Useful life. Here, the 'Cost of asset' is how much the asset was purchased for, 'Residual value' is the estimated value of the asset at the end of its useful life, and 'Useful life' is the total time period during which the asset is expected to be usable.

Imagine you buy a laptop for $1,000, expecting it to last 5 years before it's worth nothing (residual value =$0). Using the Straight Line Method, you would depreciate the laptop by $200 each year ($1,000/5 years). This is like paying a fixed monthly payment for a subscription service, where the same fee is deducted regularly until the contract ends.

• Simple and widely used. • Suitable for assets with consistent usage.

The Straight Line Method is favored in many industries for its simplicity and ease of understanding. It is especially suitable for assets that have a predictable and consistent level of usefulness over their lifetime. This means it works well for assets that don't have drastic fluctuations in utility.

Think about a public library that buys a set of encyclopedias. These encyclopedias will provide the same level of information each year and won’t become outdated quickly. Therefore, it's reasonable for the library to allocate a fixed amount of expense for these books annually as they continue to serve the same purpose.

• Easy to calculate and apply • Provides consistent expense estimates for budgeting • Useful for financial planning and cost forecasting

The advantages of using the Straight Line Method are significant. First, it is very easy to calculate, which means businesses can quickly apply it without needing advanced accounting skills. Second, because the depreciation amount remains constant each year, companies can predict their expenses with clarity, making future financial planning and budgeting much more straightforward.

Consider a school that budgets for replacing old desks every 10 years. By using SLM, the school can easily estimate the cost of depreciation each year, allowing them to save a specific amount annually so that when the time comes to replace the desks, they have the funds set aside. This is much simpler than trying to estimate varying costs each year.

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