Depreciation is one of the most common accounting terms, and one of the most misunderstood. Here's a simple definition, how the main depreciation methods work, and why depreciation in your accounts isn't the same as the tax relief you get on your assets.
If you've looked at a set of accounts, you'll have seen a line for depreciation. It's a term everyone has heard and few people could explain, and it matters, because it affects your reported profit and how you think about buying equipment. Here's a clear guide for business owners in Bristol and across the UK.
Depreciation: a simple definition
Depreciation is the process of spreading the cost of a long-term asset, such as a van, a machine or computer equipment, over the years you expect to use it. Rather than showing the whole cost as an expense in the year you buy it, your accounts show a share of it each year, reflecting the asset gradually wearing out or becoming outdated.
The logic is simple. A van that you buy for £30,000 and use for five years helps you earn money in all five of those years, so it's more accurate to spread its cost across them. Without depreciation, you'd show a big loss in the year you bought it and flattering profits afterwards.
Which assets are depreciated?
Depreciation applies to tangible fixed assets: things with a physical form that you keep and use in the business for more than a year, such as:
- Vehicles, such as vans and cars
- Plant and machinery
- Computer equipment
- Furniture, fixtures and fittings
- Buildings, though not usually the land they stand on
Intangible assets, such as purchased goodwill, are spread over their useful life in the same way, but the process is called amortisation. Stock and everyday running costs are never depreciated.
The main depreciation methods
The two methods you'll see most often in small business accounts are straight-line and reducing balance:
- Straight-line: the same amount is charged every year. A £12,000 van expected to last four years and be worth £2,000 at the end is depreciated by £2,500 a year (£12,000 minus £2,000, divided by four)
- Reducing balance: a fixed percentage of the remaining value is charged each year, so the charge is higher at first and falls over time. At 25%, the same van is depreciated by £3,000 in year one and £2,250 in year two
Straight-line suits assets that are used evenly over their life. Reducing balance better reflects assets such as vehicles and computers, which lose most of their value early on. Whichever method you choose should be applied consistently from year to year.
Depreciation and tax: the part most people miss
Here's the key point for UK businesses: depreciation isn't a tax-deductible expense. When your accountant works out your taxable profit, depreciation is added back, and you claim capital allowances on the asset instead. Capital allowances are HMRC's own system of tax relief for business assets, and they're often more generous than depreciation:
- Annual Investment Allowance (AIA): deduct the full cost of most plant and machinery from your profits in the year you buy it, up to £1 million a year. It can't be claimed on cars
- Full expensing: companies can deduct 100% of the cost of qualifying new and unused plant and machinery, with no upper limit
- Writing down allowances: for costs not covered above, you deduct a percentage each year. The main rate fell from 18% to 14% from April 2026, and the special rate is 6%
- Cars: have their own rules, based on their CO2 emissions
So a company that buys a £20,000 machine might show depreciation of £4,000 a year in its accounts for five years, while claiming the full £20,000 against its taxable profits in the year of purchase through the Annual Investment Allowance.
What about sole traders on the cash basis?
If you're a sole trader or partnership using the cash basis, you generally deduct the cost of equipment as a business expense when you pay for it, and can only claim capital allowances on business cars. It's still worth keeping a record of the assets you own, but the tax treatment is simpler.
Why depreciation matters for your business
- It gives you a truer picture of profit, year by year
- It shows the real value of your assets on your balance sheet
- It reminds you that equipment will need replacing, so you can plan and save for it
- It helps lenders and investors understand your business
Getting the treatment right
Your accountant keeps a fixed asset register, chooses sensible depreciation rates, and makes sure you claim every capital allowance available when your year-end accounts and Corporation Tax return are prepared. Talking to them before a big purchase can help you time it for the earliest tax relief. We handle this as part of our annual accounts service for businesses across Bristol and the UK, so if you're planning an investment, get in touch.
Frequently asked questions
What is depreciation in simple terms?
Depreciation spreads the cost of a long-term asset, such as a vehicle or machine, over the years it's used in the business, rather than showing the full cost as an expense in the year it was bought.
Is depreciation tax deductible in the UK?
No. Depreciation is added back when working out taxable profits. Instead, businesses claim capital allowances, such as the Annual Investment Allowance, which are often more generous.
What is the difference between depreciation and capital allowances?
Depreciation is an accounting estimate that spreads an asset's cost in your accounts. Capital allowances are HMRC's rules for tax relief on the same asset. The two often give different figures in any given year.
What is the difference between depreciation and amortisation?
They work the same way. Depreciation applies to physical assets such as vehicles and equipment, while amortisation applies to intangible assets such as purchased goodwill.
