Depreciation is the part of a fixed asset’s cost that the business has used up in a period. It touches two different places in the nominal ledger, and confusing them is the most common reason a fixed asset note will not balance.
- The depreciation charge is an expense in the profit and loss account. It starts again at nil every financial year.
- Accumulated depreciation is a balance sheet account with a credit balance that sits against the cost of the asset. It keeps building up until the asset is sold or scrapped.
Setting up the accounts
Use one expense account per asset class, mirrored by one accumulated depreciation account per class:
- Depreciation – buildings / Buildings – accumulated depreciation
- Depreciation – plant and machinery / Plant and machinery – accumulated depreciation
- Depreciation – motor vehicles / Motor vehicles – accumulated depreciation
- Depreciation – computer equipment / Computer equipment – accumulated depreciation
- Depreciation – fixtures and fittings / Fixtures and fittings – accumulated depreciation
A single expense account for all classes works in a very small business, but the notes to the accounts show the charge for each class, so splitting it in the ledger avoids a manual analysis at year end. Amortisation of intangible assets such as goodwill or purchased software belongs in its own accounts, covered in amortisation.
Straight-line and reducing balance compared
A joinery business buys a panel saw for £12,000. It expects to use it for five years and sell it for about £2,000 at the end.
Straight-line spreads the depreciable amount evenly: (£12,000 − £2,000) ÷ 5 = £2,000 a year.
Reducing balance applies a fixed percentage to the carrying amount at the start of each year. At 25%, the charge falls every year.
| Year | Straight-line charge | Straight-line carrying amount | Reducing balance charge (25%) | Reducing balance carrying amount |
|---|---|---|---|---|
| 1 | £2,000 | £10,000 | £3,000 | £9,000 |
| 2 | £2,000 | £8,000 | £2,250 | £6,750 |
| 3 | £2,000 | £6,000 | £1,688 | £5,062 |
| 4 | £2,000 | £4,000 | £1,266 | £3,796 |
| 5 | £2,000 | £2,000 | £949 | £2,847 |
Neither method is more correct. FRS 102 asks for the method that best reflects how the asset’s economic benefits are consumed. Straight-line suits buildings and fittings; reducing balance is common for vehicles and machinery that lose value fastest early on. Whichever you pick, apply it consistently to the class. A fuller comparison of methods is in our article on depreciation methods.
The monthly journal
Posting depreciation monthly rather than once a year keeps management accounts honest. For the panel saw on straight-line, the monthly charge is £2,000 ÷ 12 = £166.67:
| Account | Debit | Credit |
|---|---|---|
| Depreciation – plant and machinery | £166.67 | |
| Plant and machinery – accumulated depreciation | £166.67 |
Most accounting software lets you save this as a recurring journal. Recalculate it when assets are added or sold, otherwise the recurring amount drifts away from the register. Decide whether a new asset is depreciated from the month of purchase or the month after, write that into your policy and stick to it.
Why the charge is added back for tax
Depreciation is your own estimate, so HMRC does not accept it as a deduction. In the corporation tax computation, the depreciation charge is added back to profit, and capital allowances are deducted in its place. The same happens in a sole trader’s or partnership’s tax return. This is why you will see a large depreciation figure in the accounts and a different allowance figure on the CT600; the ledger only ever holds the accounting depreciation. The rules for claiming are in our guide to capital allowances.
Presentation in the accounts
If the profit and loss account uses Format 1 (analysis by function), the charge is spread across cost of sales, distribution costs and administrative expenses according to where the asset is used: the panel saw’s depreciation belongs in cost of sales, the office laptops’ in administrative expenses. Format 2 (analysis by nature) shows depreciation as its own line. Accumulated depreciation never appears as a separate figure on the face of the balance sheet; it is netted against cost and shown in the tangible fixed assets note.
Errors worth looking for
- Depreciating land, or depreciating fully written-down assets past nil.
- Charging VAT: depreciation is an internal journal with no VAT code.
- Leaving a sold asset’s accumulated depreciation behind, which leaves a debit or credit stranded after the disposal. The profit or loss on sale goes to fixed asset disposals in bookkeeping or losses on disposal.
- Changing useful lives retrospectively. A revised estimate affects the current and future periods only; you do not rework prior years.
The theory behind all of this is set out in our explainer on depreciation.