How to Calculate Depreciation for Business Assets

Depreciation is how you spread the cost of a business asset across its useful life, rather than writing it off in one lump sum. In the UK, the system uses capital allowances — a tax-approved way to reduce your taxable profit year by year. If you've just bought equipment, vehicles, or fixtures for your business, understanding depreciation will lower your tax bill and give you an accurate picture of your true profit.

What Is Depreciation?

When you buy a £5,000 printer for your business, it doesn't lose all its value on day one — but it does decline. Depreciation is the accounting method that mirrors this real-world wear and tear. You record a portion of that cost as an expense each year, which reduces your taxable profit.

Here's the key principle: the cost of the asset is spread over its useful life — typically 3–10 years, depending on the asset type. A company car might be useful for 5 years; office furniture for 10 years. You don't guess these figures — the tax authority (HMRC) publishes expected useful lives, and accountants follow them.

Why it matters for your tax return: If you claimed the full £5,000 as an expense in year one, you'd pay tax only on that year's remaining profit. But if you depreciate it over 5 years (£1,000/year), you reduce taxable profit by £1,000 in each of those 5 years. The total tax relief is the same either way — but the timing changes.

In the UK, however, capital allowances often work better than depreciation. More on that below.

Two Depreciation Methods: Straight-Line vs Reducing Balance

Straight-line depreciation is the simpler method. You divide the asset cost by its useful life and deduct the same amount each year.

Formula: Annual depreciation = Cost ÷ Useful life (in years)

Example: A £10,000 lathe with a 5-year useful life.

Year 1: £10,000 ÷ 5 = £2,000
Year 2: £2,000
Year 3: £2,000
Year 4: £2,000
Year 5: £2,000
Book value after 5 years: £0

Straight-line is predictable and easy to audit. Most businesses use it for buildings, furniture, and fixtures.

Reducing balance depreciation (or diminishing balance) is more aggressive early on. You apply a fixed percentage to the remaining book value each year, so the depreciation amount gets smaller.

Formula: Annual depreciation = Book value at start of year × Depreciation rate

Example: The same £10,000 lathe, but using reducing balance at 40% per year.

Year 1: £10,000 × 40% = £4,000. Book value now £6,000.
Year 2: £6,000 × 40% = £2,400. Book value now £3,600.
Year 3: £3,600 × 40% = £1,440. Book value now £2,160.
Year 4: £2,160 × 40% = £864. Book value now £1,296.
Year 5: £1,296 × 40% = £518. Book value now £778.

Notice you never reach £0 with reducing balance — there's always a residual value. This method front-loads the deduction, which can be useful if you expect an asset to lose value quickly (e.g., vehicles, computers).

Most accountants choose straight-line for simplicity. Reducing balance is popular in manufacturing, where machinery genuinely depreciates faster early on.

UK Capital Allowances: Often Better Than Depreciation

Here's where UK businesses get a boost. Instead of depreciation, HMRC allows capital allowances — a tax relief that can be more generous than straight-line depreciation.

The main types:

Annual Investment Allowance (AIA): You can claim up to £1,000,000 per year in capital allowances on most plant and machinery (bought after April 2023). This isn't depreciation over years — it's a full write-off in year one. Buy a £50,000 CNC machine? Claim the full £50,000 against your profit in the year you buy it. Learn more about the Annual Investment Allowance and check if your assets qualify.

Writing Down Allowance (WDA): If you exceed the AIA limit, or for assets that don't qualify (like vehicles), you get a 18% writing down allowance per year on plant and machinery, or 6% for integral plant (like air-con, heating, electrical systems in buildings).

Special Rate Pool: Commercial vehicles and some energy-efficient plant sit in a separate pool with a 6% WDA.

Buildings: Most buildings don't qualify for capital allowances — there's an exception for industrial buildings, which get 3% per year. Calculate your corporation tax position to see the full impact.

The AIA is why many businesses just use that — you get full relief upfront, which is better than depreciation spread over years. But you still need to understand depreciation for financial reporting (accounting rules require it), and for assets that don't qualify for allowances.

Worked Example: A Sole Trader Buying Equipment

Let's say you're a joinery business and you buy:

A £15,000 workshop lathe (qualifies for AIA)
A £8,000 delivery van
£3,000 of hand tools

Tax treatment under capital allowances:

Lathe: £15,000 under AIA — claim the full amount in year one. Your taxable profit drops by £15,000.
Van: £8,000 doesn't qualify for AIA (vehicles excluded). Goes into the 6% WDA pool. Year one relief: £8,000 × 6% = £480.
Hand tools: £3,000 under AIA — claim the full amount in year one.

Total year-one capital allowance relief: £15,000 + £480 + £3,000 = £18,480.

If you made £50,000 profit this year, your taxable profit is now £50,000 − £18,480 = £31,520 (before other expenses).

At basic rate (20%), that saves you £3,696 in income tax — significantly more than spreading the cost over years.

For financial reporting (your accounts), you still depreciate the assets on your balance sheet. But for tax, capital allowances do the heavy lifting.

How to Record Depreciation in Your Accounts

Even if you claim capital allowances for tax, you'll record depreciation in your accounting software:

Set the useful life — check your asset register or industry standards. A computer: 3 years. Vehicles: 5 years. Furniture: 10 years.
Choose the method — straight-line is standard unless you have a good reason for reducing balance.
Record the annual expense — in your P&L statement as "depreciation" (sometimes under "administrative expenses").
Update the balance sheet — subtract accumulated depreciation from the asset's cost to show net book value.

Your accountant can do this, but if you're self-employed, many accounting software packages (Xero, FreshBooks, Wave) do it automatically once you set the asset up.

Example journal entry (straight-line lathe, £10,000, 5 years):

Debit: Depreciation expense — £2,000
Credit: Accumulated depreciation — £2,000

This happens at the end of each year. After 5 years, the asset is fully depreciated on your balance sheet, even though it might still work — it's just no longer recorded as a current asset.

Common Questions

Q: Can I depreciate assets I bought secondhand?
A: Yes. Depreciation is based on what you actually paid, not the original cost. If you buy a used lathe for £3,000, depreciate it over the remaining useful life — maybe 3 years if you expect to replace it in that timeframe.

Q: What if my business hasn't made a profit?
A: You can still claim capital allowances. If you've made a loss, the allowances increase the loss, which you can carry forward to offset future profits.

Q: Is depreciation a real cash outflow?
A: No. Depreciation is a non-cash expense. You spend the £10,000 cash when you buy the asset; the depreciation just spreads that cost across the accounting periods. It affects profit, not cash.

Q: When do I stop depreciating an asset?
A: When its book value reaches zero (or a residual/scrap value you set). Then it stays at that value on your balance sheet until you dispose of it.

Q: What's a residual value, and do I need one?
A: A residual (or salvage) value is what you expect the asset to be worth when you're done with it. A £10,000 van might have a £1,000 residual value after 5 years. Depreciate from cost down to residual value: (£10,000 − £1,000) ÷ 5 years = £1,800/year. It's optional — many businesses just depreciate to zero.

Q: Do I have to claim capital allowances?
A: Capital allowances are optional, but it's rare not to claim them — you'd be forgoing tax relief. You claim them on your tax return. If you've missed them in previous years, talk to your accountant about amending returns.

Q: Can I depreciate software and patents?
A: Software and intangible assets (patents, trademarks, goodwill) are depreciated as "amortisation" — same concept, different name. They follow similar rules but usually over 5–10 years. Check the Capital Allowances guidance on GOV.UK for specifics.

Q: I'm self-employed and not VAT-registered. Does that affect depreciation?
A: Not directly. Depreciation is independent of VAT. But VAT registration does matter for capital allowances — if you're VAT-registered, you recover VAT on purchases separately, so you depreciate the net cost (ex-VAT). Understand when to register for VAT and the impact on your capital spend.

How Depreciation Affects Your Tax Liability

For corporation tax purposes, capital allowances reduce your taxable profit pound-for-pound. If you're self-employed, depreciation is an allowable deduction against your trading profit. If you're a limited company director, capital allowances are claimed in your corporation tax computation.

For Class 2 and Class 4 National Insurance, self-employed depreciation also reduces your Class 4 NI bill (charged at 8% on profits between £11,908 and £50,270 in 2025/26).

Example: You're self-employed with £45,000 trading profit. You depreciate £5,000 of equipment. Your taxable profit falls to £40,000.

Income tax (basic rate 20%): £40,000 × 20% = £8,000
Class 4 NI (8% on £40,000 − £11,908): £28,092 × 8% = £2,247.36
Total tax + NI: £10,247.36

Without the depreciation, you'd owe £10,847.36. That £5,000 depreciation saved you £600 in combined tax and NI.

Don't Overlook Allowable Deductions

Depreciation is just one way to reduce taxable profit. Small businesses often miss tax deductions — working-from-home allowance, professional subscriptions, training, vehicle mileage. And if you're investing in research and development, you might claim R&D tax credits, which can be even more valuable than depreciation.

Next Steps

Use our free calculators to model the tax impact. If you're calculating return on investment for a new purchase, our ROI calculator shows profit after depreciation and tax. And when you're ready to file, make sure you understand your capital allowances claim — it's often the biggest tax relief available to growing businesses.