The most important method that is used for calculating depreciation is the straight line method. However, there are many positive and negative points associated with this method.
Positives associated with straight line method:
- Assets can be completely negated:
Since the value of asset is actually split over the period of its useful life hence depreciation is to be calculated on original cost of this asset. So, taking this into consideration assets can be taken to the level of zero value.
- Simple method:
Since calculation by this method is merely a division, hence it is understandable by most of the people. Also, chances of miscommunication are reduced considerably.
- It is suited for small firms:
Since small firms have a limited number of assets and machinery, hence this method becomes easy for them. Taking graphical representation as well as formula method into consideration, a detailed answer can be obtained.
- The total depreciation knowledge is charged:
To get the actual value of the amount spend, one just needs to multiply yearly amount of depreciation with a number of years this asset has been used by the company.
- Assets with less value profited:
Just like small firms, this method is also suitable specifically for assets that have lower value associated with them. In this case, calculation becomes faster and easier.
- Suited for firms with mixture of old and new assets:
This method of depreciation calculation is suitable for those firms which have a mixture of both old and new machinery in terms of assets. The maintenance charges on new machines are low, whereas those for old machines are high and hence a balance is obtained.
There are a number of disadvantages associated with this system as well.
Limitations of straight line methods:
- No chance of replacement:
That amount which has been obtained in lieu of depreciation cost is used by the business for a regular period. However, with this method, the firm has to make arrangements of getting funds, even though depreciation has been charged on an annual note.
- Extra pressure on the last years:
It is common knowledge that in the final years of an asset, it has to undergo a whole set of repair and therefore certain maintenance cost is to be applied. Since initial years, charges levied are less, so that is surely a problem for getting the correct amount.
- Not suitable for assets with long life span:
This is one method that is strictly suitable for small firms and assets having small life shelf. Whenever those goods that have extended life span are taken into consideration, this formula does not justify that in a correct manner.
- Loss of interest:
The major depreciation charge that is received each year is specifically used by the firm for its personal marketing and investments. However, in certain other cases, this interest that is received from depreciation is used for investment in securities and other external business activities.
With its range of positive and negative points, this straight line method has multiple uses in present times.
Usages of straight line method:
The points where this method is applied:
- Those assets that require less expense and maintenance cost uses this technique.
- This is specifically useful for those firms which have a large number of machinery in their domain.
- This is useful for those assets which comparatively have lower
- When this technique is used for a mixture of old and new goods, then high costs associated with old assets as well low costs associated with new assets balance each other.
Used specifically in a variety of places, this method is most suitable for getting the actual depreciation amount.
Calculation of Depreciation on Adding to Assets:
Since it is taken that a business is a continuing activity, hence apart from the fixed assets that are present in the company, there may arise an occasion, where a company may have to buy certain other goods for carrying forth their production process.
This extra asset that is being bought can be termed as additional or capital expenditure. Since this will increase the value of the assets, hence depreciation charges would be placed on these as well! It will be charged at the current rate, since the date when it has been added to the total assets.
Treating the Sale of Assets:
It is quite natural for a company to sell off their assets that are no longer able to provide them the required value. Reasons for sale can be due to obsolete nature of that machinery, bringing of a new machinery against the old one.
In either case, this sales amount is to be taken into consideration, as in most cases it is used for internal purposes of the company rather than being invested with any external security.
For any person who is dealing with this straight line method for calculation of depreciation amount, it is important that a detailed knowledge of this topic is there.