Subject: Industrial Engineering And Management

Topic: Cost Accounting and Financial Management

Difficulty: Medium

Straight line method:

This method is also termed as Constant Charge Method. Under this method, depreciation is charged for every year will be the constant amount throughout the life of the asset.

Accordingly depreciation is calculated by deducting the scrap value from the original cost of an asset and the balance is divided by the number of years estimated as the life of the asset. The following formula for calculating the periodic depreciation charge is:

$Depreciation =\frac{(Original Cost of Asset-Scrap Value)}{(Estimated Life of an Asset)}$

(OR)

$Depreciation =\frac{(C-S)}{N}$ Where, D = Depreciation Rate

C = Original Cost of Asset

S = Salvage or Scrap Value

N = Estimated Useful Life

Example:

From the following information you are required to calculate depreciation rate:

Cost of the Machine Rs.30000

Erection Charges Rs.3000

Estimated useful life 10 years

Estimated Scarp Value Rs. 3000

Solution:

Calculation of depreciation rate for every year:

$Depreciation =\frac{(Original Cost of Asset-Scrap Value)}{(Estimated Life of an Asset)}$

$=\frac{(Rs.33,000 - Rs.3,000)}{10}$

= Rs.3000

Thus, the amount of depreciation would be Rs. 3,000 for every year.

Merits:

• Simple and easy to calculate.

• Original cost of asset reduced up to Scrap Value at the end of estimated life.

• Estimated useful life of the asset can be estimated under this method.

Demerits:

• It does not consider intensity of use of assets.

• It ignores any additions or opportunity cost while calculating depreciations.

• It ignores effective utilization of fixed assets; it becomes difficult to calculate correct depreciation rate.

• Under the assumption of constant charges of maintenance of assets it is impossible to calculate true depreciation.