Why a Van You Bought Last Year Costs You Money This Year
If your business buys a £30,000 van in April, it does not really cost you £30,000 in April. The van is going to keep working for you for years, hauling stock or staff or tools, and the money it earns will arrive slowly. Counting the whole price as a single hit in month one would make April look like a disaster and every other month look better than it is.
Depreciation is the accounting trick that fixes this. It spreads the cost of a long-life asset across the years it actually helps the business. This guide explains how depreciation works in UK accounts, the two methods you will see most often, why land is the famous exception, and the trap that catches a lot of business owners: depreciation in your accounts is not the same thing as what HMRC lets you claim against tax.
Defining Depreciation
Depreciation is the systematic allocation of a fixed asset's cost across the period it is expected to be useful to the business. In plain English, it is the way accounts recognise that a van, a laptop, a kitchen fit-out or a piece of machinery wears out, becomes obsolete, or simply gets used up over time.
Three things have to be true before depreciation makes sense:
- The asset is a fixed asset, meaning it is held for use in the business and not for resale
- It has a useful life of more than one year
- Its value to the business declines through use, time, or obsolescence
A delivery van, a server, a fork lift, a shopfit, a commercial coffee machine and an espresso grinder all qualify. Stock you bought to sell does not. A short-life tool you will throw away after one job does not. And, as we cover below, land does not either.
Depreciation also lives on the right side of the matching principle, which is the idea that costs should appear in the same period as the revenue they helped create. If a printing press helps you bill customers for five years, a fifth of its cost should sit against each of those five years of sales.
Fixed Assets and the Numbers That Drive Depreciation
Before you can depreciate anything, you need three numbers. None of them is given to you; you decide them when the asset is bought, and you have to be able to defend the choice.
- Cost: the purchase price plus everything needed to get the asset ready for use. For a delivery van, that includes delivery charges, signwriting, and any modifications. It does not include road tax, fuel, or insurance, which are running costs
- Residual value: an estimate of what the asset will be worth at the end of its useful life. For a 5-year-old van you expect to sell for £4,000, the residual value is £4,000
- Useful life: the period in years (or sometimes units of output) the business will get value from the asset
The amount you actually depreciate is the depreciable amount, which is cost minus residual value. Useful life sets the speed.
These are estimates, and FRS 102 Section 17 requires you to review them at least at each reporting date. If a van you thought would last five years is clearly going to die at three, the depreciation rate goes up from that point. You do not go back and restate the earlier years.
The Straight-Line Method
The straight-line method is the simplest and most common approach in UK small business accounts. It assumes the asset gives up its value evenly across its life, like a battery discharging at a constant rate.
The formula is straightforward:
Annual depreciation = (Cost − Residual Value) ÷ Useful Life
A worked example. A bakery buys a commercial oven for £12,000. It expects the oven to last 8 years and to be worth £800 at the end. The annual depreciation is:
(£12,000 − £800) ÷ 8 = £1,400 per year
That £1,400 hits the profit and loss account every year for 8 years, and the asset's carrying value on the balance sheet falls by £1,400 each year until it reaches the £800 residual at the end of year 8.
Straight-line is the right choice when:
- The asset is used roughly evenly over its life
- You want a stable, predictable depreciation charge
- You are dealing with fit-outs, buildings improvements, office furniture, or anything where wear is gradual
Most UK small companies pick this method for most of their assets, and we usually agree. The tax position is what it is, and a clean, predictable accounting charge is easier to read in the management accounts.
The Reducing Balance Method
The reducing balance method front-loads the depreciation. You apply a fixed percentage to the net book value at the start of each year, so the charge is large in year one and falls every year after.
The formula is:
Annual depreciation = Net Book Value at Start of Year × Depreciation Rate
A worked example with a 25% rate. A construction firm buys a £20,000 mini excavator. Using a 25% reducing balance rate:
| Year | Opening NBV | Depreciation | Closing NBV |
|---|---|---|---|
| 1 | £20,000 | £5,000 | £15,000 |
| 2 | £15,000 | £3,750 | £11,250 |
| 3 | £11,250 | £2,813 | £8,437 |
| 4 | £8,437 | £2,109 | £6,328 |
| 5 | £6,328 | £1,582 | £4,746 |
After 5 years the excavator sits at £4,746 on the books and the depreciation charge has shrunk every year.
Reducing balance is the right choice when:
- The asset loses most of its value early. Vehicles are the obvious case
- High repair costs in later years roughly offset lower depreciation, giving a smoother total cost of ownership in the P&L
- The economic benefit really does fall off, not just the second-hand market price
A practical note. Reducing balance never reaches zero by formula alone. You either set a residual value at the end of the useful life and adjust the final year's depreciation to land on it, or you keep applying the rate and write off any small remainder when the asset is disposed of.
Why Land Does Not Depreciate
This is the question that catches almost every first-year accounting student, and it catches plenty of business owners too. Land does not depreciate. Buildings on the land do. The site value underneath does not.
The reason sits in the definition. Depreciation only makes sense for an asset whose useful life is finite and whose value to the business declines through use or obsolescence. Land does not wear out. It does not become obsolete. A field used for storage in 2026 will still be a field in 2086. FRS 102 Section 17.4 is explicit that land normally has an unlimited useful life and so is not depreciated.
There are nuances worth knowing:
- Leasehold land is depreciated (or, more precisely, amortised) over the lease term, because the lease itself has a finite life
- Land used for mining or quarrying can be depreciated where extraction physically consumes the land
- Site preparation that has a finite life (drainage, hard standing) is treated separately from the underlying land and depreciated
- The building on the land is always separated out and depreciated over its useful life, typically 25 to 50 years for a commercial building
In a freehold purchase, the price usually covers both land and the building. UK accounting requires you to split the cost between the two on a reasonable basis and depreciate only the building portion. Where the split is not obvious, a chartered surveyor's valuation is the cleanest source. Skipping the split and depreciating the lot is a common error that overstates depreciation and understates profit.
Recording Depreciation in the Accounts
The double entry is the same for both methods:
- Debit Depreciation expense (P&L)
- Credit Accumulated depreciation (balance sheet, against the asset)
Accumulated depreciation is what is called a contra asset. It sits next to the asset's original cost and is subtracted from it to give the net book value (NBV). On the face of the balance sheet you usually see one tidy number, but the fixed asset note in the accounts breaks out cost, accumulated depreciation, additions, disposals, and the depreciation charge for the year.
When an asset is sold or scrapped, both its cost and accumulated depreciation come off the books. The difference between what it sold for and its remaining NBV is a profit or loss on disposal that goes through the P&L. If your depreciation estimates were too cautious, you tend to make a profit on disposal. If they were too generous, you tend to make a loss. Neither is dramatic; both are a sign that the estimates could be tightened next time.
Depreciation Is Not the Same as Capital Allowances
This is the single most important thing for a UK business owner to understand about depreciation, and it is the bit textbooks gloss over.
The depreciation you put in your accounts is not allowed as a tax deduction by HMRC. Every penny of it is added back when your taxable profit is calculated. Instead, HMRC gives you a parallel system called capital allowances, which is HMRC's own version of depreciation for tax purposes.
The two systems run side by side and almost never agree:
| Depreciation (Accounting) | Capital Allowances (Tax) | |
|---|---|---|
| Set by | The business, under FRS 102 | HMRC, by statute |
| Purpose | Spread cost across useful life | Give tax relief on capital spend |
| Methods | Straight-line, reducing balance, others | Annual Investment Allowance, Writing Down Allowances, Full Expensing, First Year Allowances |
| Rate | Whatever your accounting policy says | Set by law, currently 18% main pool, 6% special rate |
| Land and buildings | Building depreciates, land does not | Most buildings get no allowance; structures and buildings allowance is 3% on qualifying spend |
The headline rates change frequently. The Annual Investment Allowance sits at £1 million of qualifying expenditure per year and gives 100% relief in the year of purchase. Full expensing for companies allows 100% first-year relief on most new plant and machinery with no cap. Cars and second-hand assets have their own rules. HMRC publishes the current detail in its Capital Allowances Manual at CA20000 onwards and the overview on GOV.UK.
The practical consequence. Your accounts can show a £1,400 depreciation charge for the oven while your tax computation gives you the full £12,000 in year one under AIA. The £1,400 is added back, the £12,000 is deducted, and the timing difference flows through to deferred tax. Most small companies in FRS 102 1A can ignore deferred tax in the accounts, but the timing mismatch is still real.
This is also why "what depreciation policy should I use to save tax?" is a question with no useful answer. Your depreciation policy does not change your tax bill. It changes how your accounts look to the bank, the buyer, and your own management. The tax bill is run on a separate set of rules.
Our tax planning work for clients almost always starts with a fixed asset review for exactly this reason. Spend that has been wrongly treated as a repair (full deduction) or wrongly capitalised (slow deduction) is the most common place we find money in a tax computation.
A Practical Opinion on What Most Businesses Get Wrong
A few patterns we see over and over when we pick up a new client's books:
- The fixed asset register is missing or out of date. Assets that were sold or scrapped years ago are still being depreciated, while recent purchases are sitting in repairs. A clean register, reconciled annually, is the foundation
- Useful lives are off the shelf and not reviewed. A laptop set to depreciate over four years almost always dies before then. A shop fit-out set to five years almost always lasts longer. Reviewing and adjusting the estimates is required by FRS 102 and is the rare bit of accounting policy that genuinely improves the numbers
- Repair vs improvement is fudged. A £6,000 new boiler replacing a broken one is usually a repair; a £6,000 new boiler that doubles capacity and was not needed is usually an improvement. The line matters because repairs are deducted fully, improvements are capitalised and depreciated
- Small assets are capitalised when they should be expensed. Most businesses set a capitalisation threshold, often £500 or £1,000. Anything below it goes straight to the P&L. Capitalising every £80 office chair clogs the fixed asset register and changes nothing of substance
None of this is dramatic on its own. Across a few years and a growing business, the effect on the management accounts is bigger than people expect.
Depreciation, Working Capital, and the Rest of the Balance Sheet
Depreciation sits on one part of a wider picture. Fixed assets and their depreciation pair naturally with stock, the trade balances, and cash. Together they form the operating part of the balance sheet that drives almost every meaningful management ratio.
If you want the rest of that picture, our explainers on trade payables and trade receivables cover the short-term half. Depreciation is the long-term half. The thing they have in common is that none of them is intuitive at first, and all of them quietly tell you more about the health of a business than the headline turnover number ever will.
Good cloud accounting software handles the mechanics of depreciation runs in a couple of clicks once the asset register is set up. We use Xero with most clients and the fixed asset module gives you a clean depreciation schedule, automatic monthly journals, and a register that survives a staff change.
How IAK Can Help
Depreciation is one of those areas where the rules are not complicated, but the practical work of keeping the register clean and the policies sensible is the kind of thing that slips when a business is busy. We deal with it as part of the year-end on every accounting client, and we run a fixed asset review for new clients as standard.
If you are not sure whether your fixed asset register is up to date, whether you are claiming the capital allowances you are entitled to, or whether your depreciation policy is doing what it should, that is a quick conversation worth having.
Take a look at our accounting, bookkeeping and tax planning services, or contact us and tell us roughly what you own and how it is being treated. We will tell you straight whether anything is worth fixing.