Understand how to calculate UK depreciation on assets, depreciation percentage rates (straight-line and reducing balance methods) and the double-entry bookkeeping entries used in accounting.
Table of contents
- 1. What is Depreciation?
- 2. Types of Depreciation Methods
- 3. How to Calculate UK Depreciation on Assets
- 4. How to Calculate Depreciation Using the Straight Line Method
- 5. How to Calculate Depreciation Using the Reducing Balance Method
- 6. Double-Entry Bookkeeping for Depreciation
- 7. What is the Double-Entry for Depreciation on the Sale of an Asset?
- 8. Is Depreciation Allowable for Corporation Tax?
- 9. Depreciation and Self-Assessment
- 10. Depreciation Rate for Land of Buildings
Friendly Disclaimer: Whilst I am an accountant, I’m not your accountant. The information in this article is legally correct but it is for guidance and information purposes only. Everyone’s situation is different and unique so you’ll need to use your own best judgement when applying the advice that I give to your situation. If you are unsure or have a question be sure to contact a qualified professional because mistakes can result in penalties.
1. What is Depreciation?
Fixed assets, over time, begin to lose value* and this decrease in value needs to be reflected in the accounts using depreciation. Depreciation is the write off of fixed assets over a set period of time to reflect the use and eventual depletion in the value of the asset.
* special rules apply to land and property
2. Types of Depreciation Methods
There are two main methods used in the UK to calculate depreciation on assets:
- Reducing balance method
2.1 Straight Line Method
The straight-line method is the simplest way to depreciate fixed assets. Using the formula below, assets are written off in equal amounts over their useful life.
Depreciation = Cost of Fixed Asset ÷ Useful Life of Fixed Asset
2.1 Reducing Balance Method
The reducing balance method of depreciation is used when a fixed asset loses more value at the start of its life compared to the end of its life. Examples of these types of assets include a van or lorry.
In the first year, depreciation is calculated as a percentage of the asset cost. Then in the subsequent years, depreciation is calculated at the same percentage based on the remaining value from the previous year rather than the original cost.
3. How to Calculate UK Depreciation on Assets
Here are the steps to take to calculate depreciation:
- Choose Asset Type
Fixed assets are generally grouped by asset type in accounting. So all computer equipment are grouped together for example and depreciated using the same rates.
- Determine Useful Life
The useful life of a fixed asset is the number of years it is used by a business to generate income and determines the length of time an asset is depreciated over.
- Determine Residual Value
Residual value is the estimated value of a fixed asset at the end of its useful economic life. Say, for example, a business purchases equipment for £10,000 which it estimates will be in use for 10 years at which point the scrap value will be £4,000 – the residual value in accounting will be £4,000.
- Choose Depreciation Method
The main depreciation methods businesses commonly use are the straight line and reducing balance method, depending on what is most suitable for the asset.
4. How to Calculate Depreciation Using the Straight Line Method
You have purchased a computer for £1,000 and estimate you will keep it for 3 years. At the end of the 3 years, the computer will have no residual value. The computer will be depreciated at £333.33 per year for 3 years (£1,000 ÷ 3 years).
If the computer has a residual value in 3 years of £200, then depreciation would be calculated on the amount of value the laptop is expected to lose:
- Value of the asset (£1,000 – £200) = £800
- Depreciation £800 ÷ 3 = £266.67
5. How to Calculate Depreciation Using the Reducing Balance Method
You have purchased a company pickup truck for £44,000 and estimate it will lose 30% of its value in the first year. Depreciation using the reducing balance method for the first 5 years would be calculated out as follows:
|Year||Value||Depreciation (30%)||Book Value remaining|
6. Double-Entry Bookkeeping for Depreciation
The double-entry for depreciation in accounting is:
- Dr Depreciation (profit and loss account)
- Cr Fixed asset accumulated depreciation (balance sheet)
Depreciation writes off a portion of the cost of a fixed asset as a cost in the profit & loss account, reducing profit. This reflects the use of the asset as a cost during the useful life.
7. What is the Double-Entry for Depreciation on the Sale of an Asset?
When a business sells an asset, the net book value (cost less accumulated depreciation) needs to be removed from the balance sheet. Any sales proceeds will be offset against the net book value to establish whether there has been a profit or loss on the sale of the fixed asset.
Say, for example, a VAT registered business makes the credit purchase of a fixed asset for an invoice value of £15,000 including VAT, the double-entry to record the initial purchase would be:
- Dr Fixed Asset £12,500
- Dr VAT £2,500
- Cr Trade Creditors £15,000
It then sells the asset for £5,000 and has accumulated depreciation of £3,000. The double-entry on the sale of the asset would be:
- Dr Bank £5,000
- Dr Accumulated depreciation £3,000
- Cr Fixed Assets £12,500
- Cr Profit on sale of fixed assets £4,500
8. Is Depreciation Allowable for Corporation Tax?
Depreciation is not allowable for corporation tax. Depreciation rates vary from business to business meaning that one may choose a more aggressive depreciation rate than another and benefit from tax relief sooner. To make things fair between all businesses, depreciation is added back on the corporation tax computation and replaced by capital allowances.
9. Depreciation and Self-Assessment
Depreciation is not an allowable expense for self-assessment. Self-employed business owners must claim capital allowances and the annual investment allowance instead of depreciation.
But where self-employed individuals choose to use the cash basis when filling in their tax return, they can claim the full cost of the asset in the year they buy it**.
**different rules apply for cars
10. Depreciation Rate for Land of Buildings
In the UK it is generally accepted that land will always have a value of at least the same price it was purchased for, if not more. For this reason, it is common for land and buildings not to be depreciated in UK accounting.