The basic formula for straight line depreciation is pretty straightforward. All you do is take the purchase price of an asset, or the historical value of the asset, then subtract the salvage value of that asset, and divide the entire thing by the total number of years that an asset is considered to be of value and benefit to the company. This last number is also called the useful life of an asset. Here's possibly an easier way to see how it works:

Purchase price of an asset - approximate salvage value of an asset / estimated useful life of asset

Let's demonstrate straight line depreciation through an example. Let's say that you buy a car for company use for about $27,000. This is the purchase price, or the historical value, of your asset. You expect that you will be able to sell this car for about $7000 when your company doesn't need it any more. By working with your accountants and the IRS, you determine that the useful life of your car is about 7 years. So the way that you determine the depreciation is as follows:

27,000 purchase price - 7000 salvage value
/
7 years of the estimated useful life

27,000 - 7000 / 7 = about $2857

What do you do with this last number? The 2857 dollars is the amount of money that your business will annually take as the depreciation charges on this particular asset.

The idea behind straight line depreciation calculation is the assumption that an asset will lose the same amount of value each year with depreciation.

So what happens when you sell the vehicle, and if you sell it for more than the depreciation value, which is also known as the net book value? Then what you do is you consider the excess depreciation as a gain for your company. You will include the excess depreciation when you calculate the net income. The IRS is also going to recognize this gain in the form of excess depreciation as part of your income, which means that you will be taxed on it. This income is what is known as capital gains.

What happens, however, if you sell your asset, in this case your car, for less than the book value of the car? Then you are considered to have lost money, and it is called at capital loss. The capital loss on the sale of an asset is actually tax deductible when you are filing your taxes.

Figuring out the depreciation of an asset is based on what is known as the counting principle and the matching principle. The matching principle means that you will have to match the amount of money claimed in depreciation with the value of an asset. Another way to look at depreciation is that it is simply an accounting method that spreads the historical cost of an asset over a number of years-the depreciable or the useful life of an asset. The spreading out of the historical cost isn't going to have any effect on the way that the market works, but it's a convenient way for companies to determine the value of the assets that they are currently holding so that they can also get a genuine idea of their total income and the worth of the company.

Correctly figuring your depreciation on an asset can also be helpful when you are determining how much income you need to pay taxes on. The depreciation of assets decreases your overall income, as determined by the IRS.