Straight Line Depreciation
Straight line depreciation is the most common method for determining the depreciation of an asset. It is also the most simple. Basically the company estimates the scrap or residual value of the asset at the end of its useful life (this can be 0 or even negative) and subtracts it from the purchase price or book value of the asset. That amount is then divided by the number of years the asset will be depreciated and the company then uses that number to depreciate the asset by equal amounts over the life of the asset.
Annual Depreciation Expense = Cost of Asset – Residual Value/Useful Life of Asset
Real world example. A company buys a PC for $3000 and it has a useful life of 5 years. The residual value of the PC is estimated to be $500. So we have $3000-$500 = $2500/5 (years) = $500. In a case like this the company will depreciate the PC by $500 each year.
Book value of the asset starts at the original cost and is decreased by the depreciation amount each year. So in the example above the book value at the beginning of the first year would be $3000, but at the end of the first year the book value is $2500 because of the $500 depreciation. If at any time the company chooses to sell the asset and the sale price is greater than the current book value of the asset they are required to pay taxes on the gain. Conversely if they sell the asset for less than book value they are allowed to claim the difference as a tax loss.