Straight line amortization
Straight line amortization is an accounting method used to spread the cost of an asset over its useful life. It is calculated by dividing the cost of the asset by the number of accounting periods in its life. Straight line amortization is used to spread the cost of the asset evenly throughout each period and the amortization is recorded as an expense.
The advantages of straight line amortization include:
- Straight line amortization is easy to calculate, as it is based on a simple formula and does not require complex calculations.
- Straight line amortization is also easy to understand and can be used to compare different assets and their respective amortization.
- Straight line amortization is a reliable method for accounting for the cost of an asset, as it results in the same amortization amount over the life of the asset.
Straight line amortization is a reliable and easy-to-use method of accounting for the cost of an asset over its useful life. By calculating and recording the amortization expense as an expense, it allows businesses to accurately track the cost of their assets and compare different assets in terms of their respective amortization.
Example of Straight line amortization
A company purchases a machine for $2,000 with a useful life of 5 years. The straight line amortization for the asset would be:
Therefore, the company would record an amortization expense of $400 for each year of the asset's useful life.
Formula of Straight line amortization
When to use Straight line amortization
- Straight line amortization should be used when the useful life of an asset is known.
- Straight line amortization should also be used when the cost of the asset is known and will not change over time.
- Straight line amortization should be used when the benefits of the asset are expected to be spread evenly throughout the asset's useful life.
Straight line amortization is an ideal method of accounting for the cost of an asset when the useful life and cost of the asset is known and the benefits of the asset are expected to be spread evenly throughout its life. By using a simple formula to calculate the amortization expense, businesses can accurately track the cost of their assets and compare different assets in terms of their respective amortization.
Types of Straight line amortization
There are two types of straight line amortization:
- Fixed Amortization, which is when the amortization amount is fixed over the life of the asset.
- Variable Amortization, which is when the amortization amount changes over the life of the asset due to a change in the asset's value or use.
Both types of amortization are calculated using the same formula, but the amortization amount for each period may differ depending on the type of amortization being used.
Steps of Straight line amortization
- Firstly, the cost of the asset should be determined.
- Secondly, the useful life of the asset should be determined.
- Thirdly, the formula for straight line amortization should be used to calculate the amortization amount.
- Lastly, the amortization amount should be recorded as an expense for the period.
Advantages of Straight line amortization
- Straight line amortization is simple to calculate as it requires only a few inputs.
- It is easy to understand and compare different assets and their respective amortization.
- The results are reliable and consistent over the life of the asset as the same amortization amount is recorded for each period.
Limitations of Straight line amortization
- Straight line amortization does not take into account the time value of money, and so the amortization may not reflect the actual cost of the asset.
- Straight line amortization may result in higher costs in the earlier accounting periods, as the cost of the asset is spread evenly over the life of the asset.
- Straight line amortization may not accurately reflect the actual usage of the asset and may therefore result in over-amortization or under-amortization.
- Sum of the Years' Digits (SYD): SYD is an accelerated amortization method that uses the sum of the years’ digits in its calculations. This method allows for larger payments in the earlier years of the asset’s life and smaller payments in the later years.
- Declining Balance: Declining balance is a form of accelerated depreciation. This method allows for larger payments in the earlier years of the asset’s life and smaller payments in the later years.
Straight line amortization and its related approaches are used to spread the cost of an asset over its useful life. Straight line amortization is an easy-to-use method that results in a consistent amount of amortization over the life of the asset. The other approaches, such as Sum of the Years' Digits and Declining Balance, are accelerated methods of amortization that allow for larger payments in the earlier years of the asset’s life.
Straight line amortization — recommended articles |
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References
- Ben-Shahar, D., Margalioth, Y., & Sulganik, E. (2009). The straight-line depreciation is wanted, dead or alive. Journal of Real Estate Research, 31(3), 351-370.
- Jennings, R., & Marques, A. (2013). Amortized cost for operating lease assets. Accounting Horizons, 27(1), 51-74.