What is the Straight Line and Written Down Method?
Different calculations are specified in the accounting rules to provide for depreciation. The two most commonly used methods are the Straight Down Method and Written Down Method. The calculations have different individual suitability and aspects. A company chooses one of these methods to provide depreciation according to their requirement.
The Straight Line Depreciation Method
A straight-line basis is a method of calculating depreciation and amortization. Also known as straight-line depreciation, it is the simplest way to work out the loss of value of an asset over time. A straight-line basis is calculated by dividing the difference between an asset's cost and its expected salvage value by the number of years it is expected to be used. In accounting, many different conventions are designed to match sales and expenses to the period in which they are incurred.
Companies use depreciation for physical assets and amortization for intangible assets such as patents and software. Both conventions are used to expense an asset over a longer period of time, not just in the period it was purchased. In other words, companies can stretch the cost of assets over many different time frames, which lets them benefit from the asset without deducting the full cost from net income.
The Written Down Value Method
Written-down value is a method used to determine a previously purchased asset's current worth and is calculated by subtracting accumulated depreciation or amortization from the asset's original value. The resulting figure will appear on the company's balance sheet.
The Written Down Value method is a depreciation technique that applies a constant rate of depreciation to the net book value of assets each year, thereby recognizing more depreciation expenses in the early years of the life of the asset and less depreciation in the later years of the life of the asset. In short, this method accelerates the recognition of depreciation expenses systematically and helps businesses recognize more depreciation in the early years. It is also known as the Diminishing Balance Method or Declining Balance Method.
The Formula to Calculate Annual Depreciation as Per Straight Line Method
With the straight-line depreciation method, the value of an asset is reduced uniformly over each period until it reaches its salvage value. Straight-line depreciation is the most commonly used and straightforward depreciation method for allocating the cost of a capital asset. It is calculated by simply dividing the cost of an asset, subtracting its salvage value by the useful life of the asset.
The Straight Line Calculation Steps
Determine the cost of the asset.
Subtract the estimated salvage value of the asset from the cost of the asset to get the total depreciable amount.
Determine the useful life of the asset.
Divide the sum of step 2 by the number obtained in Step 3 to get the annual depreciation amount.
The Straight Line Depreciation Formula for an Asset is as Follows
Annual Depreciation Expense = \[\frac{(Cost of the asset - Salvage value)}{Useful life of the asset}\]
Where:
The cost of the asset is the purchase price of the asset
Salvage value is the value of the asset at the end of its useful life
The useful life of an asset represents the number of periods/years in which the asset is expected to be used by the company
Straight Line Method And Written Down – A Comparative Analysis
In the accounting glossary, the term depreciation is often used, for writing off the value of the asset over its useful life. It is nothing but a decrease in the value of the fixed asset because of continuous use, the passage of time, and technological obsolescence. There are nine different methods of calculating the depreciation of assets out of which the Straight-Line Method and written down value method is widely used. In the Straight-Line Method (SLM), an equal amount of depreciation is written off every year. Conversely, in the written down value method (WDV), there is a fixed rate of depreciation that is applied to the opening balance of the asset every year.
Further, the Analysis is Illustrated in the Following Points
A method of depreciation in which the cost of the asset is spread uniformly over its lifespan by writing off a fixed amount every year is the SLM method. While a fixed rate of depreciation is charged on the book value of the asset over its useful life in the WDV method.
To calculate depreciation, SLM applies to the original cost and the WDV method applies to the written down value of the asset.
The annual depreciation charge remains fixed during the useful life in case of SLM. In the WDV method, it reduces every year.
The value of the asset is completely written off in SLM but the WDV value is not completely written off.
The amount of depreciation in SLM is initially lower. In WDV, it is initially higher.
The impact of repairs and depreciation on P&L A/C is on an increasing trend in SLM while the impact remains constant in WDV.
SLM is appropriate for assets with negligible repairs and maintenance like leases, copyright. In WDV assets whose repairs increase as they get older like machinery, vehicles, etc.
To summarize, in a straight-line method, depreciation is calculated on the original cost. On the other hand, in the written down value method, the calculation of depreciation is based on the written down value of the asset. The annual depreciation charge in SLM remains fixed during the life of the asset.
Straight Line and Written Down Method
Students must have got a proper understanding of what are the different types of methods of depreciation accounting.
The straight line and written down method have been discussed above in detail. These paragraphs talked about their definitions, methods, formula, steps to calculate and the analysis statement.
Some students might find it a difficult task to select a strategy that would work for a subject like Accountancy that has both practical and theoretical concepts.
To aid them with proper guidance and advice, we've listed a few points which the students may follow to ace their preparation for Accounts. Read ahead!
Studying accounting from the textbook is way too different from studying theoretical subjects
You would be able to understand 70% of the text while reading a theoretical subject like business studies whereas accountancy involves both theoretical and practical topics and it takes time to understand them. But that never means that you won’t be able to understand, try once, twice, and even more. You can skip some parts of the text too and move ahead but make sure that you understand the concept behind every question.
Understand why it is important
You cannot excel in the subject without understanding ‘why’ it is being studied. As you read more, you’ll be able to know the logic behind what you’re reading. Hence, students shall believe in extensive reading. They are also advised to focus more on conceptual learning so that they can give logical resonance to everything that they do, in terms of accounting.
Solve more to understand how it works
Just knowing why you’re studying accounting won’t let you understand how it works. Solving more problems will make your concepts clear and enhance your knowledge, hence making it easier for you to understand which concept should be applied to a particular problem. Students are, therefore, advised to keep their spirits high and put their hands on more and more practice sums.
Analyze what you’ve already studied before moving further
It is important to revise what you’ve already studied in the previous unit before moving further to the next part. It would’ve worked well in the case of business studies if you study well at first and revise a few days before the exam but in accounting, it’s not the same. Regular effort is required before starting the next topic, what’s more, important is whether you’re clear with the previous topics or not. Hence, students shall be regular with their studies and ensure a proper understanding of every topic that is a part of their syllabus.
Do not refer to textbooks/ notes while doing homework
We often have a habit of checking solutions while attempting examples and it surely helps in achieving the accurate answer but it would be more beneficial if we do homework without referring to any textbook/ notes as it will help our brain work and think with a wider aspect, also it will help us gain confidence. Try not to refer to your notes until you try your best.
Remember the formats
We usually solve the whole question but forget the format of accounts. Format carries marks’ weightage and also, is an important part of accounting as a subject. You should be familiar with all the formats that are used in every question.
Do not hesitate
If you’re new to this subject, you might have so many doubts but it’s okay! There’s nothing to hesitate. Instead, you should ask your teacher if you’re having any difficulty while understanding any of the topics.
To conclude, students shall not believe the myths of one subject being easy and another difficult. You shall always try to divide your time according to the requirements. Being a student, it becomes your responsibility to ace learning and carefully decide the subject mix.
Lastly, remember that you have to keep going despite the number of challenges that encounter you.
FAQs on Straight Line vs. Written Down Method of Depreciation
1. What is the fundamental difference between the Straight-Line Method (SLM) and the Written Down Value (WDV) Method of depreciation?
The fundamental difference lies in the basis of calculation. In the Straight-Line Method (SLM), depreciation is calculated on the original cost of the asset, resulting in a fixed amount of depreciation each year. In contrast, the Written Down Value (WDV) Method calculates depreciation on the book value (or written down value) of the asset, which decreases every year.
2. How is the annual depreciation calculated using the Straight-Line Method formula?
The annual depreciation under the Straight-Line Method is calculated by subtracting the asset's estimated salvage value from its original cost and then dividing by its useful life. The formula is:
Annual Depreciation = (Cost of Asset - Salvage Value) / Useful Life of Asset.
This ensures the expense is spread evenly over the asset's life.
3. How is depreciation calculated under the Written Down Value (WDV) or Diminishing Balance Method?
Under the WDV method, a fixed percentage rate of depreciation is applied to the opening book value of the asset at the beginning of each year. The book value is the original cost minus the accumulated depreciation. This results in a higher depreciation amount in the early years of the asset's life, which gradually reduces as the book value diminishes.
4. Why is the depreciation amount constant in SLM but decreases every year in the WDV method?
The depreciation amount is constant in SLM because the calculation is always based on the original cost of the asset, which does not change. In the WDV method, the depreciation is calculated on the book value of the asset. Since depreciation is deducted from the book value each year, the base for the next year's calculation is lower, causing the depreciation amount to decrease over time.
5. For which types of assets is the Straight-Line Method more suitable, and why?
The Straight-Line Method is most suitable for assets that provide a consistent level of benefit over their useful life and have low repair costs. This is because the value diminishes uniformly. Examples include:
- Leasehold properties
- Patents and copyrights
- Furniture and fixtures
The method's simplicity and consistent charge against profit make it ideal for these types of assets.
6. When is the Written Down Value method a better choice for a business?
The Written Down Value method is a better choice for assets that are more productive and generate more revenue in their early years, and whose repair costs increase as they get older. By charging higher depreciation initially, it better matches the higher expense with higher revenue. This is ideal for assets like:
- Machinery and plant
- Vehicles
- Computers and electronics
7. Can you illustrate the difference in depreciation value over two years for an asset using both SLM and WDV?
Certainly. Assume an asset costs ₹1,00,000 with a 10% depreciation rate.
Using Straight-Line Method (SLM):
- Year 1 Depreciation: 10% of ₹1,00,000 = ₹10,000. Closing Value = ₹90,000.
- Year 2 Depreciation: 10% of ₹1,00,000 = ₹10,000. Closing Value = ₹80,000.
Using Written Down Value (WDV) Method:
- Year 1 Depreciation: 10% of ₹1,00,000 = ₹10,000. Closing Value = ₹90,000.
- Year 2 Depreciation: 10% of ₹90,000 (the new book value) = ₹9,000. Closing Value = ₹81,000.
As you can see, the depreciation charge under WDV decreases in the second year.
8. How does the choice between SLM and WDV impact a company's Profit and Loss Account and Balance Sheet differently in the initial years?
In the initial years:
Under the WDV method, the depreciation expense is higher. This leads to a lower reported profit on the Profit and Loss Account and a lower asset value on the Balance Sheet compared to SLM.
Under the SLM method, the depreciation expense is lower and constant. This results in a higher reported profit and a higher asset value on the Balance Sheet in the early years.
9. Is it true that an asset's value becomes zero under SLM but not under WDV?
Yes, that is generally correct. Under the Straight-Line Method, an asset's value can be written down to its salvage value, which can be zero. Under the Written Down Value Method, because depreciation is a percentage of the remaining balance, the book value of the asset mathematically approaches zero but never actually reaches it.
