A Possible Economic Rationale for Straight‐Line Depreciation

Straight‐line depreciation (SL) appears to be a crude procedure that is unsupported by economic logic. Nevertheless, internationally, it is the most widely used method of allocating the costs of fixed assets to accounting periods by way of depreciation charges. Many authors attribute its use to its simplicity. That justification may be deemed to be insufficient, since ideally SL should provide accounting figures with economic meaning under known assumptions. Such meaning might be defined by reference to the net present value (NPV) calculus, which is recommended in the literature of financial management for the evaluation of economic flows associated with the acquisition of fixed assets. After briefly considering economic depreciation alternatives discussed in the literature, this article selects the Ladelle/Brief/Grinyer Earned Economic Income (EEI) calculus as a theoretical model for the examination of SL depreciation. EEI provides signals which are consistent with those given by NPV and can satisfy the accounting constraint that one should recognize realised profits only. The article employs mathematics and deterministic computer simulation to explore some circumstances in which SL provides figures which approximate to the net investment charges using the EEI calculus. It shows that there are many patterns of declining annual benefits from ownership for which SL provides an approximation to EEI net charges that could be considered to be adequate. Consequently SL often provides more economically interpretable information, and consequently is more defensible, than is typically assumed in the literature relating to accounting.