You've bought a laptop, a van, or a piece of machinery, and you're wondering how to record its cost in your accounts. Do you put the whole lot through in one year, or spread it out? That's where depreciation comes in.
Depreciation is how you spread the cost of a long-lived asset across the years you actually use it. Get it right and your profit figure tells the truth. Get it wrong and your accounts can look wildly off, one year too low, the next too high.
This guide explains what depreciation is in plain terms, how to calculate it two different ways, where it sits in your accounts, and the one thing that trips up most business owners: why depreciation and the tax relief you actually claim are not the same thing.
What is depreciation in simple terms?
When something depreciates, it loses value over time. In accounting, depreciation is the method you use to spread the cost of an asset across its useful life, rather than recording the whole cost in the year you buy it.
Think of a car. The moment you drive it off the forecourt it's worth less, and the more miles you put on it, the less it's worth when you sell it. The same idea applies to your business assets. A new laptop, a machine, or a desk is at its highest value the day you buy it, and that value falls as you use it.
In accounting terms, depreciation is a non-cash expense. No money leaves your bank account when you record it. It simply reflects how much of an asset's value has been used up during an accounting period.
By matching the cost of the asset to the years it helps you earn money, you get a far more honest picture of your real profit.
Why do businesses use depreciation?
Depreciation does three useful jobs for your business.
It gives you an accurate profit figure
Without depreciation, you'd record the full cost of a £10,000 machine in year one. That makes your profit look artificially low in the first year and artificially high in the years after. Spreading the cost matches the expense to the revenue the asset helps generate, which is the core "matching" principle of accounting.
It helps you plan for replacements
Assets don't last forever. A laptop might serve you four years and a machine ten. Tracking depreciation reminds you that a replacement is coming, so you can set money aside before the bill lands.
It keeps your accounts credible
If you're applying for finance, seeking investment, or preparing to sell, clean depreciation records show you understand your true costs. Lenders and buyers notice.
A quick but important point: depreciation is an accounting figure you control. It is not the tax relief you claim from HMRC. We'll come back to that, because it's where most confusion lives.
How do I calculate depreciation?
There are two methods most UK businesses use:
- Straight-line depreciation (the fixed instalment method)
- Reducing balance depreciation (the diminishing balance method)
Both spread an asset's cost over its useful life. They just do it on different shapes of curve. Let's take each in turn.
What is straight-line depreciation?
Straight-line is the simplest and most common method. You spread the cost evenly across each year of the asset's useful life.
The straight-line formula
Depreciation per year = (Cost of asset - Residual value) / Useful life
Residual value is what you expect the asset to be worth at the end of its life. If you assume that's nil, the formula simplifies to:
Depreciation per year = Cost of asset / Useful life
Illustrative example: a £1,000 laptop
Say you buy a laptop for £1,000 at the start of the year and expect it to last four years, with no residual value.
£1,000 / 4 years = £250 per year.
You'd record £250 as a depreciation expense each year. After four years the laptop's book value is nil.
| Year | Opening value | Depreciation | Closing value |
|---|---|---|---|
| 1 | £1,000 | £250 | £750 |
| 2 | £750 | £250 | £500 |
| 3 | £500 | £250 | £250 |
| 4 | £250 | £250 | £0 |
When straight-line works best
It suits assets that deliver steady value over their life, such as office furniture, fixtures, and equipment with even usage. It's also the easiest to calculate, which makes it the natural choice for sole traders and small businesses. If you want a hand getting your fixed asset register set up properly, our bookkeeping services cover exactly this.
What is reducing balance depreciation?
Reducing balance charges depreciation as a percentage of the asset's current book value each year. You expense more in the early years and less as the asset ages.
The reducing balance formula
Depreciation = Book value at start of year x Depreciation rate
The rate is set as a percentage, often 20% or 25%, based on how quickly the asset loses value.
Illustrative example: a £5,000 camera
A business buys a camera for £5,000 and applies a 20% reducing balance rate.
| Year | Opening book value | Rate | Depreciation | Accumulated depreciation | Closing book value |
|---|---|---|---|---|---|
| 1 | £5,000 | 20% | £1,000 | £1,000 | £4,000 |
| 2 | £4,000 | 20% | £800 | £1,800 | £3,200 |
| 3 | £3,200 | 20% | £640 | £2,440 | £2,560 |
| 4 | £2,560 | 20% | £512 | £2,952 | £2,048 |
Notice how the yearly charge shrinks, because it's always 20% of the falling book value, not the original cost. The asset never quite reaches nil under this method.
When reducing balance works best
It suits assets that lose most of their value early or become outdated quickly, such as computers, cameras, vehicles, and some machinery. It reflects the reality that a two-year-old laptop is worth far less than a new one, even if both still work.
Straight-line vs reducing balance: what's the difference?
Both spread cost over the useful life. They differ in shape, complexity, and what's left at the end.
| Factor | Straight-line | Reducing balance |
|---|---|---|
| Annual expense | Same every year | Higher early, lower later |
| Calculation | Cost / useful life | Book value x rate |
| Best for | Assets with steady value | Assets that lose value fast |
| Complexity | Very simple | More involved |
| Examples | Furniture, fixtures | Computers, vehicles, cameras |
| Book value at end | Usually nil | Usually leaves a residual amount |
The right choice depends on the asset. Whichever you pick, apply it consistently, because your depreciation policy should be steady from year to year.
Where does depreciation go in my accounts?
Depreciation appears as an expense in your profit and loss account, sitting alongside costs like salaries, rent, and professional fees. You subtract it from revenue when working out net profit.
Illustrative example: depreciation in a profit and loss account
| Item | Amount |
|---|---|
| Revenue | £100,000 |
| Cost of sales | (£30,000) |
| Gross profit | £70,000 |
| Salaries | (£25,000) |
| Rent | (£10,000) |
| Depreciation | (£5,000) |
| Other expenses | (£8,000) |
| Net profit | £22,000 |
The flip side of the expense lives on your balance sheet as accumulated depreciation, which we'll cover next.
What is accumulated depreciation?
Accumulated depreciation is the running total of all the depreciation charged against an asset since you bought it. It grows each year.
- Depreciation is the charge for a single period. Example: your laptop depreciates £250 this year.
- Accumulated depreciation is the total so far. Example: after three years it's £750.
While the yearly depreciation charge sits in your profit and loss account, accumulated depreciation sits on your balance sheet, reducing the asset's value:
- Cost of asset: £1,000
- Less accumulated depreciation: (£750)
- Net book value: £250
This shows both what you paid and what the asset is worth in your books today.
Is depreciation the same as Capital Allowances?
No, and this is the single most important point in this guide. They're easy to confuse because they do a similar job, but they're separate systems.
- Depreciation is an accounting figure. You choose the method and the useful life. It shapes the profit you report in your accounts.
- Capital Allowances are the tax version. HMRC sets the rules, and they decide how much you can deduct when working out your taxable profit.
Because HMRC won't let you deduct your own depreciation, the standard process is to add your depreciation back when calculating taxable profit, then deduct Capital Allowances instead.
For many assets, the Annual Investment Allowance (AIA) lets you deduct the full cost in the year of purchase, up to £1,000,000 a year (gov.uk). Limited companies buying main-rate plant and machinery may instead use full expensing, a permanent 100% first-year allowance, for qualifying spend (gov.uk).
Illustrative example: a £15,000 computer purchase
A limited company buys £15,000 of computers in 2025/26. In its accounts, it uses straight-line depreciation over four years, recording £3,750 of depreciation in year one.
For tax, it claims the full £15,000 under the Annual Investment Allowance. So in year one, when working out taxable profit, the accountant:
- adds back the £3,750 of accounting depreciation, and
- deducts £15,000 of AIA.
The net effect in year one is to reduce taxable profit by £15,000 rather than £3,750. The accounts still show £3,750 a year for four years, but the tax relief lands up front. This is why your depreciation charge and your tax deduction rarely match, and why it pays to keep the two clearly separated.
Capital Allowances rules can get involved, especially for cars, integral features, and the special rate pool. If you'd like to make sure you're claiming everything you're entitled to, book a free call with a Zmartly accountant and we'll sort your fixed asset and allowances position together.
Frequently asked questions
What is depreciation in accounting?
Depreciation in accounting is the systematic spreading of an asset's cost over its useful life. It's a non-cash expense that reflects the decline in value of tangible assets like equipment, vehicles, and computers as they age and are used in the business.
What is depreciation in simple words?
It's how businesses account for things losing value over time. Like a car worth less the more you drive it, assets such as laptops and machinery lose value as you use them. Depreciation spreads the cost across the years you'll use the asset, rather than recording it all at once.
How do I calculate straight-line depreciation?
Divide the cost of the asset (less any expected residual value) by its useful life in years. For example, a £2,000 computer expected to last five years with no residual value gives £2,000 / 5 = £400 of depreciation a year.
What's the difference between depreciation and amortisation?
Depreciation applies to tangible assets you can touch, like machinery, vehicles, and equipment. Amortisation applies to intangible assets, like patents, trademarks, and certain software. Both spread cost over a useful life; they just apply to different kinds of asset.
Can I claim tax relief on depreciation?
Not directly. In the UK you can't deduct your own depreciation for tax. You claim Capital Allowances instead, which follow HMRC's rules. In practice your accountant adds depreciation back and deducts Capital Allowances to work out taxable profit.
Which depreciation method should I use?
For most small businesses, straight-line is the simplest and works well for assets with steady value. If you hold technology or vehicles that lose value quickly, reducing balance can reflect reality more closely. Apply whichever you choose consistently, and check with your accountant.
What happens when an asset is fully depreciated?
Its book value reaches nil (or its residual value), but you can keep using it. If you later sell or dispose of it, you record the proceeds, since there's no remaining book value to offset them against.
