Depreciation is the accounting process of allocating an equipment asset’s depreciable amount over the period the business expects to use it. It helps accounts reflect the consumption of equipment over time rather than treating every purchase as one month’s operating cost.
In this article
- Record the asset cost
- Estimate its useful life
- Apply the accounting policy
- Review depreciation and disposals
It is not a cash reserve, a guaranteed fall in market value or the same thing as tax relief. Understanding those differences makes equipment decisions and profit reports easier to interpret.
Start with cost, useful life and residual value
For a straightforward equipment asset, the depreciable amount is its recorded cost less the estimated residual value at the end of its useful life. Useful life reflects expected business use, not necessarily how long the item could physically survive.
FRS 102, section 17, addresses systematic depreciation over useful life, the available-for-use starting point and review of changed estimates. Your accountant should confirm the framework and policy applying to the asset.
Ask practical questions: how intensively will the equipment be used, how quickly might it become unsuitable, what maintenance is expected and is any residual value realistic? A heavily used delivery vehicle and an occasional-use workshop machine may need different assessments.
Do not choose a life merely to create a preferred profit figure. Document the business reasoning and revisit it when conditions change.
Follow a straight-line example
Illustrative example: a business acquires equipment with an accounting cost of £5,000. It expects to use it for four years and estimates a £1,000 residual value. Assume straight-line depreciation is appropriate, the asset is ready for use at the start of year one and there are no later changes or impairment.
The depreciable amount is £4,000: £5,000 less £1,000. Dividing £4,000 by four years gives annual depreciation of £1,000.
| Point in time | Accumulated depreciation | Carrying value |
|---|---|---|
| Acquisition | £0 | £5,000 |
| End of year one | £1,000 | £4,000 |
| End of year two | £2,000 | £3,000 |
| End of year three | £3,000 | £2,000 |
| End of year four | £4,000 | £1,000 |
The carrying value is the recorded cost less accumulated depreciation in this simplified example. It is not a valuation certificate or a promise of sale proceeds.
Understand the effect on profit and cash
The purchase causes a cash movement when paid, or creates a financing obligation if financed. Depreciation normally creates no new bank payment when the charge is recorded. It allocates cost in the accounts.
If the illustrative equipment is paid for immediately, cash falls by £5,000 at purchase, while the full-year depreciation charge is £1,000. If the purchase is financed, the repayment schedule creates separate cash commitments. Do not put depreciation into a cash forecast as if it were another supplier payment.
It can still be useful to plan future replacement funding. That is a budgeting decision, not a result of the depreciation entry automatically setting money aside.
Keep the asset register useful
Record the description, cost, ready-for-use date, method, useful life, residual value and accumulated depreciation. Identify location and ownership, and retain purchase and finance documents.
Review items that have been sold, scrapped, damaged or stopped being useful. Fully depreciated equipment can remain in use; reaching the end of the depreciation schedule does not itself mean the asset has disappeared. Conversely, a listed asset may no longer exist even though it still has a carrying value.
Changes in expected use or condition may require review of estimates or a separate impairment assessment. Ask the accountant about the treatment rather than extending a schedule silently or writing an asset down to an arbitrary number.
Deal with disposal and tax separately
Illustrative disposal: after two complete years in the example, carrying value is £3,000. If the equipment is sold for £3,500 with no selling costs, the simplified accounting gain is £500. Remove the asset’s original cost and accumulated depreciation as part of the disposal record.
The tax result is considered separately. HMRC’s capital allowances guidance explains tax relief for qualifying business assets. Depreciation is not itself the capital allowance claim, and a disposal can require its own tax assessment. Retain the sale document and acquisition history.
For a clear explanation of asset costs in your accounts, discuss EPOS annual and financial accounts services. Provide the asset register and supporting documents so the discussion covers the actual equipment, useful life and reporting basis rather than a generic depreciation percentage.