What is depreciation (and why does it matter)?

As a UK business owner you’ll often buy assets to help run your business, for example, a laptop, car, office furniture, and machinery. These items are often used in the business over a number of years, but they don’t hold their value forever. Over time, these assets lose value through wear and tear, obsolescence, or simply because they’re no longer fit for purpose. This reduction in value is known as depreciation, and understanding how it works is important when it comes to managing your finances and filing your accounts.​

In simple terms, depreciation is an accounting method that allows businesses to spread the cost of an asset over a period of time (also known as ‘its useful life’).​

Instead of reflecting the full cost of the asset as an expense in the year it was purchased, you spread the cost over its estimated lifespan.​

For example, if you bought a piece of machinery for £50,000 and it’s expected to last 10 years, you would reflect £5,000 of costs each year for 10 years, rather than reflecting the full $50,000 in 1 year.​

Depreciation helps acknowledge that your assets contribute to your business’s income over its entire lifespan rather than only in the year it was purchased.​

Depreciation might sound like an accounting technicality, but it plays an important role in the financial management of a company.​

In the UK, businesses use depreciation to reflect the reduction in value of their assets over time. This isn't just for internal tracking; it's also a requirement under UK accounting standards to show depreciation in company accounts. This ensures the financial statements give a true and fair view of the business's financial position.​

Here are a few key reasons why depreciation matters.​

Depreciation spreads the cost of an asset over its useful life, rather than recording it all as an expense in the year of purchase. This gives a clearer picture of profitability, ensuring your profit and loss account shows a more realistic cost of using the asset each year.​

It also helps with consistency in reporting, which is important when comparing financial performance across different periods, especially useful for management decisions, investor confidence, or when applying for finance.​

Over time, assets lose value. Depreciation helps track this by showing the current book value of each asset i.e. the original cost less accumulated depreciation.​

Example: ​

A van purchased for £25,000​

Accumulated depreciation over a few years: £15,000​

Current book value = £10,000​

This is particularly useful for internal planning, asset management, and in some cases insurance valuations.​

While depreciation appears in your company accounts, it's not a tax-deductible expense for UK corporation tax purposes. Instead, HMRC uses a separate system called capital allowances.​

This means you "add back" depreciation when calculating your taxable profits, and then claim capital allowances, which offer tax relief on certain qualifyin purchases of equipment, vehicles, and other assets. These don't always match the depreciation rate used in your accounts, but they still offer valuable tax savings over time.​

So while you won't get tax relief based on your depreciation figures, you do still benefit from tax deductions on capital expenditure.​

Generally, you can depreciate assets that:​

Common depreciating assets include:​

You can’t depreciate things like stock, land, or everyday expenses like internet or electricity. (Land is generally not a depreciating asset as it typically doesn’t decline in value).​

There are a few different ways depreciation can be calculated, but you don’t need to do all the maths yourself. That’s what your accountant is for.​

Here are two common methods used by UK businesses:​

This method lets you claim more depreciation in the early years of owning an asset, and less as it gets older. It’s similar to how a car loses value more quickly in the first few years.​

Depreciation is calculated as a percentage of the asset's net book value each year, not the original cost.​

Example:​

You buy a car for £20,000 and apply a 20% depreciation rate on a reducing balance basis.​

Each year, the depreciation is based on the remaining value, not the original purcahse price.​

This method spreads the depreciation evenly over the asset's useful life. It's a simpler and more predictable approach.​

Example:​

You purchase machinery for £50,000 with a useful life of 10 years. Using this method, you'd depreciate it by £5,000 each year.​

You claim the same amount of depreciation each year until the asset's value is fully written off.​

Depreciation is more than just an accounting term. It’s a valuable tool that can impact your business's profitability.​

Understanding how it works and why it’s important is useful for effectively managing your business assets, operational efficiency, and finances.​

For tailored assistance on how depreciation applies to your business assets and to ensure you’re maximising eligible deductions, it's always recommended to consult your accountant.​

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