Accounting technology / Glossary / Depreciation

What is depreciation in accounting?

Definition

Depreciation is the way accounting spreads the cost of a long-lived asset, such as equipment, vehicles or buildings, over the years it is used. Instead of charging the full cost when it is bought, the business records part of it as an expense each period, and the asset's carrying value on the balance sheet falls by the same amount.

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Common methods: Straight-line, reducing balance
UK tax relief: Capital allowances
US tax system: MACRS

How depreciation works

Depreciation starts from cost less any expected residual value, spread over the asset's useful life. Straight-line depreciation charges the same amount each year: a 10,000 machine with no residual value and a five-year life costs 2,000 a year. The reducing balance method charges a fixed percentage of the remaining value, so more falls in early years. Each period's entry debits depreciation expense and credits accumulated depreciation; land is not depreciated. Under IFRS and US GAAP, useful lives and residual values are estimates that companies review. Tax rules usually replace accounting depreciation with their own allowances: in the UK, capital allowances such as the Annual Investment Allowance of £1 million a year; in the US, the Modified Accelerated Cost Recovery System (MACRS) for most business property.

Common questions

What is the difference between depreciation and amortisation?+

Both spread a cost over time. Depreciation applies to tangible assets such as machinery and buildings; amortisation applies to intangible assets such as software licences, patents and acquired customer lists.

Is depreciation a cash cost?+

No. The cash leaves when the asset is bought. Depreciation is a non-cash expense, which is why it is added back to profit in the indirect cash flow statement.

Is accounting depreciation tax-deductible?+

In the UK and US, tax uses its own rules instead: capital allowances in the UK and MACRS depreciation in the US. Accounting depreciation is added back and the tax allowance deducted.