Sensitivity of Annual Depreciation Expense to Varying Estimates of Useful Life and Residual Value
Using the straight-line method of depreciation, annual depreciation expense is calculated as:
Cost — Residual value
Estimated useful life
Assume the cost of an asset is $10,000. If, for example, the residual value of the asset is estimated to be $0 and its useful life is estimated to be 5 years, the annual depreciation expense under the straight-line method would be ($10,000-$0)/5 years=$2,000. In contrast, holding the estimated useful life of the asset constant at 5 years but increasing the estimated residual value of the asset to $4,000 would result in annual depreciation expense of only $1,200 [calculated as ($10,000-$4,000)/5 years]. Alternatively, holding the estimated residual value at $0 but increasing the estimated useful life of the asset to 10 years would result in annual depreciation expense of only $1,000 [calculated as ($10,000-$0)/10 years]. Shows annual depreciation expense for various combinations of estimated useful life and residual value.