Depreciation allocates the cost of a fixed asset across its useful life. It reflects the decline in value due to use, age, or obsolescence and is essential for accurate financial statements and tax calculations.
Why Depreciation Matters
- Accounting: Matches the cost of an asset against the revenue it generates
- Tax: Depreciation deductions reduce taxable income
- Business decisions: Helps determine when to replace equipment
Method 1: Straight-Line Depreciation
The simplest method — equal depreciation each year.
Annual depreciation = (Cost − Salvage value) ÷ Useful life (years)
Example: Machine costs £20,000, salvage value £2,000, useful life 9 years.
Annual depreciation = (20,000 − 2,000) ÷ 9 = £2,000/year
| Year | Book value (start) | Depreciation | Book value (end) |
|---|---|---|---|
| 1 | £20,000 | £2,000 | £18,000 |
| 2 | £18,000 | £2,000 | £16,000 |
| 9 | £4,000 | £2,000 | £2,000 |
Method 2: Declining Balance (Reducing Balance)
Applies a fixed percentage to the current book value — front-loads depreciation.
Depreciation = Book value × Depreciation rate
Example: 25% declining balance on a £10,000 asset:
| Year | Book value (start) | Depreciation (25%) | Book value (end) |
|---|---|---|---|
| 1 | £10,000 | £2,500 | £7,500 |
| 2 | £7,500 | £1,875 | £5,625 |
| 3 | £5,625 | £1,406 | £4,219 |
| 4 | £4,219 | £1,055 | £3,164 |
Used for vehicles, computers, and technology — assets that lose value fastest early on.
Method 3: Double Declining Balance
A more aggressive version: 2 × straight-line rate applied to book value.
DDB rate = (1 ÷ Useful life) × 2
Annual depreciation = Book value × DDB rate
Example: 5-year asset, cost £15,000:
- Straight-line rate = 1/5 = 20%
- DDB rate = 40%
Method 4: Units of Production
Depreciation based on actual usage — ideal for manufacturing equipment.
Depreciation per unit = (Cost − Salvage value) ÷ Total expected units
Annual depreciation = Units produced × Depreciation per unit
UK Capital Allowances
For UK tax, businesses use Capital Allowances rather than accounting depreciation:
- Annual Investment Allowance (AIA): 100% first-year deduction up to £1 million
- Writing Down Allowance (WDA): 18% for main pool, 6% for special rate pool
- Full Expensing: 100% first-year allowance for qualifying plant and machinery
Which Method to Choose?
| Asset type | Recommended method |
|---|---|
| Buildings, furniture | Straight-line |
| Vehicles, computers | Declining balance |
| Manufacturing equipment | Units of production |
| UK tax filing | Capital Allowances |