What Is Depreciation?

Depreciation is the accounting method for allocating a fixed asset’s cost across the years it is used, so the expense lands in the periods that get the benefit rather than all at once at purchase. Buy a delivery van and it does not become worthless on day two - it earns its keep over years, and depreciation makes the accounts reflect that. Each period a slice of the cost is recorded as an expense, and the asset’s book value falls by the same slice.

The word “depreciation” is also used loosely to mean “losing value”, and that is where most confusion starts. In accounting it is a cost allocation, not a valuation: the schedule is driven by what you paid and how long you expect to use the item, not by what a buyer would pay today. The formal name for the idea behind it is the matching principle - costs are recognised in the same periods as the revenue they help produce.

What you will learn

• How depreciation works
• What causes an asset to depreciate
• Depreciation methods compared
• A worked example, two methods side by side
• Typical useful lives by asset type
• When depreciation starts, pauses and stops
• Where depreciation shows up in the accounts
• Disposal: what happens at the end
• Depreciation vs amortisation, depletion and impairment
• Accounting depreciation vs tax depreciation
• Reviewing depreciation under IFRS (IAS 16)
• Common depreciation mistakes
• Depreciation in an asset register
• FAQ

How depreciation works

Four inputs drive every depreciation calculation:

• Cost - what the asset cost to buy and put into service, including delivery, installation and commissioning; the capex figure, not just the sticker price.
• Useful life - how long the organisation expects to use it, in years or in units of output; see useful life.
• Salvage value - what it is expected to be worth at the end; see salvage value, also called residual value.
• Method - the rule for distributing cost minus salvage value across the useful life.

Cost minus salvage value is the depreciable amount - the total that will eventually be expensed. The running total of expense recorded so far is called accumulated depreciation, and cost minus accumulated depreciation is the asset’s net book value, the figure that appears on the balance sheet.

What causes an asset to depreciate

Two forces sit behind every useful-life estimate, and knowing which one dominates is how you set a sensible life.

• Physical deterioration - wear from use, hours run, vibration, heat, weather, corrosion. A power tool on a site every day wears out on a different clock from the same tool in a workshop cupboard.
• Obsolescence - the asset still works but is no longer worth using. Newer kit is faster or cheaper to run, requirements changed, or the software and security updates stopped. This is why an end-of-support date can end an asset’s life long before anything breaks; see end of life.

That split explains why a laptop and a workbench bought for the same money get very different lives: one is killed by obsolescence in three to five years, the other physically survives a decade or more. It is also why depreciation is not a market valuation. The charge follows your estimate of consumption, not the second-hand market, so net book value and fair market value routinely diverge in both directions. And it applies only to tangible fixed assets - see tangible vs intangible assets for the other half of the picture.

Depreciation methods compared

Four methods cover almost everything you will meet. The choice should reflect how the asset actually gives up its value, and it should be applied consistently within an asset class.

Two details trip people up on declining balance. First, salvage value is not subtracted before the calculation - the rate is applied to opening book value - but it still acts as a floor: once book value reaches salvage, the charge stops. Second, “double” is only the common variant; 150% declining balance is equally valid, and the multiple should match how fast the asset really fades.

A fifth option exists for fleets of similar low-value items: group or composite depreciation, where a whole class - a set of identical monitors, say - is depreciated as one pool at a single rate rather than item by item. It saves admin at the cost of per-asset accuracy, so it works best where individual items are interchangeable.

Whichever you pick, the output is a depreciation schedule: a year-by-year table of charge, accumulated depreciation and closing book value for each asset.

A worked example, two methods side by side

A company buys a laptop for €1,400, expects to use it for four years, and estimates it can be resold for €200 at the end. The depreciable amount is €1,400 - €200 = €1,200.

Straight-line: €1,200 / 4 years = €300 per year.

Double-declining balance: the straight-line rate is 1/4 = 25%, so the DDB rate is 2 x 25% = 50%, applied each year to the opening book value.

Both methods expense the same €1,200 in total and land on the same €200 salvage value - the difference is timing. Notice year three: 50% of €350 would be €175, which would push book value below the €200 salvage floor, so the charge is truncated to €150 and depreciation then stops. Under straight-line the same laptop still carries €300 of cost in its final year, when it is arguably contributing least.

A second example on units of production. A delivery van costs €32,000, is expected to be worth €4,000 at the end, and to cover 280,000 km in its life. The depreciable amount is €28,000, so the rate is €28,000 / 280,000 = €0.10 per km. Drive 45,000 km in year one and the charge is €4,500; a quiet year of 18,000 km costs €1,800. For company vehicles and hard-worked plant this matches expense to actual wear far better than a calendar-based method - provided somebody records the odometer or hour-meter reading each period.

Typical useful lives by asset type

These are working conventions, not rules. Your accounting policy, local tax authority and actual operating conditions override them, and the estimate should reflect how long you will use the item, not how long it could theoretically last.

Two practical notes. Where a documented hardware refresh cycle already exists, use it - the refresh plan is the useful life, and lining the two up stops the accounts and the replacement budget telling different stories. And a life set once at purchase and never revisited is the most common source of drift; see useful economic life for how the estimate should be framed and reviewed.

When depreciation starts, pauses and stops

Start. Depreciation begins when the asset is available for use - in the location and condition intended by management - not on the invoice date and not when someone first switches it on. A machine that is delivered, installed and commissioned starts depreciating even if the first production run is weeks away, and a spare laptop sitting in storage ready to issue is already depreciating. (US practice uses the near-identical “placed in service” test.)

Part-years. For anything bought mid-year the charge is normally prorated: annual charge x months held / 12. Some regimes simplify this with conventions - a half-year charge in the year of acquisition, or a mid-month rule - which trade a little accuracy for a lot less arithmetic.

Pauses. Under the cost model there are none. An asset that is idle, mothballed or awaiting repair keeps depreciating, because time-based obsolescence does not stop just because the machine did. The exception is a usage-based method, where zero output in a period genuinely means a zero charge.

Stop. Depreciation ceases at the earlier of two events: the asset is fully depreciated (book value has reached salvage value), or it is derecognised on disposal. A fully depreciated asset that is still in use carries no further charge but stays on the register at cost less accumulated depreciation, with nil or near-nil net book value, until it actually leaves. See asset lifecycle for how these stages line up with the operational side.

Where depreciation shows up in the accounts

The journal entry is the same every period:

• Debit depreciation expense - an income statement line, usually within operating expenses (opex).
• Credit accumulated depreciation - a contra-asset account on the balance sheet.

Accumulated depreciation is not a separate asset; it nets off against property, plant and equipment. That is why a well-presented balance sheet note shows all three figures - original cost, accumulated depreciation, and net book value - rather than a single number. The original cost stays visible, which matters: it is the anchor for insurance, replacement planning and any later disposal calculation.

The cash flow statement is where the crucial point lands: depreciation is a non-cash expense. No money moves when the entry is posted. The cash left the business when the asset was bought, and that outflow already appeared as capital expenditure in investing activities. So in the operating section depreciation is added back to profit, and it is the “D” that gets added back in EBITDA. It does reduce reported profit and, indirectly, taxable profit - it just never touches the bank balance on its own.

That two-sided nature is exactly why finance and operations argue about it: to finance it is a profit line, to operations it is a schedule of assets quietly ageing towards replacement. See fixed asset accounting for how the two views are reconciled.

Disposal: what happens at the end

When an asset is sold, scrapped, traded in or donated it is derecognised: both its original cost and its accumulated depreciation come off the books, and the difference between the proceeds and the net book value is recorded as a gain or loss on disposal in the income statement.

• Sell a machine with €3,000 net book value for €4,000 and you book a €1,000 gain.
• Scrap the same machine for nothing and you book a €3,000 loss.

A loss on disposal is not a mistake - it usually just means the useful life or salvage estimate was optimistic, which is useful feedback for the next estimate.

The failure mode is administrative, not arithmetical. Operations scraps, sells or loses the item; finance is never told; and the asset keeps depreciating on paper as a ghost asset. The consequences compound: the balance sheet overstates what the organisation owns, insurance premiums cover equipment that no longer exists, replacement budgets are built on a fiction, and the year-end count throws up discrepancies nobody can explain. Wiring asset disposal into the same record the depreciation schedule is built from - along with the ITAD paperwork and any certificate of destruction for data-bearing kit - is what keeps that from happening. Where an asset dies mid-life with book value still on it, the remaining amount comes off through an asset write-off.

Depreciation vs amortisation, depletion and impairment

Four terms that get used interchangeably and should not be:

The first three are planned and gradual; impairment is unplanned and event-driven - the asset is damaged, superseded or no longer expected to generate what it should, so its carrying amount is cut to what it can actually recover. Two things follow. An impairment resets the base: future depreciation is calculated on the new, lower carrying amount over the remaining life. And impairment is not a substitute for depreciation - the systematic charge carries on afterwards. For software specifically, note that a perpetual licence is amortised, not depreciated, even though it may be managed in the same register as the hardware it runs on; see software licence management.

Accounting depreciation vs tax depreciation

The two are rarely the same number, and in many jurisdictions they are calculated on completely separate tracks. The general mechanism, wherever you are: the depreciation in your accounts is added back to accounting profit, and a statutory allowance is deducted instead. Because the two schedules run at different speeds, timing differences arise, and those differences are what deferred tax accounts for.

In the UK the statutory system is capital allowances. The Annual Investment Allowance gives 100% relief on up to £1 million of qualifying plant and machinery expenditure a year, and companies can also use full expensing on qualifying new main-rate assets. Two changes announced for 2026 are worth diarising: a new 40% first-year allowance for main-rate expenditure applies from 1 January 2026, and the main pool writing down allowance falls from 18% to 14% from 1 April 2026 for corporation tax (6 April 2026 for income tax), with a hybrid rate applied to accounting periods that straddle the change.

In the US the parallel is MACRS, which assigns statutory recovery periods and rates by asset class, alongside Section 179 expensing and bonus depreciation for qualifying purchases.

Elsewhere, local rate tables and asset classifications apply, and they can differ sharply from the lives in the table above. The figures and examples on this page are illustrative and euro-denominated for convenience; they are not a rate table for any particular country.

This is general information, not tax advice. Rates, thresholds and eligibility change, and the treatment of any specific purchase depends on your circumstances - check with your accountant or tax adviser before relying on it.

Reviewing depreciation under IFRS (IAS 16)

Under IAS 16, the international standard for property, plant and equipment, depreciation is not a set-and-forget calculation.

• Annual review. The useful life, the residual value and the depreciation method must be reviewed at least at each financial year end. If expectations have changed, the schedule changes.
• Applied prospectively. A revised life or method is a change in accounting estimate under IAS 8, not an error: you adjust the current and future years’ charges over the remaining life. You do not restate prior years.
• Component depreciation. Where a significant part of an asset has a different useful life from the whole, it is depreciated separately - an engine inside a machine, a roof inside a building, a battery pack inside a vehicle. Otherwise the replacement of that part sits awkwardly against a single blended life.
• Cost model vs revaluation model. Most organisations carry assets at cost less accumulated depreciation and impairment. IAS 16 also permits a revaluation model, carrying assets at fair value less subsequent depreciation, applied consistently across a whole class.

The practical catch: an annual review is only credible if someone can confirm the asset still exists and is still in the condition the estimate assumes. That is a physical job, not a spreadsheet job - a fixed asset audit or physical inventory count with proper asset verification is what turns the review from a formality into something with evidence behind it. It also feeds directly into asset valuation work.

Common depreciation mistakes

Most depreciation problems are record-keeping problems wearing an accounting costume.

• Depreciating assets that are gone. Disposed, stolen or scrapped kit still on the schedule is the single most common defect, and the hardest to spot from the numbers alone.
• Capitalising what should have been expensed. Items below the capitalisation threshold belong in this year’s costs, not on a four-year schedule; see asset capitalisation for where the line sits.
• Missing the in-service date. Using the invoice date instead of the available-for-use date throws out the first year’s proration and everything after it.
• One blanket useful life for everything. Applying “five years” to phones, furniture and forklifts alike guarantees all three are wrong.
• Never revisiting an estimate that has clearly failed. If a class of assets is routinely replaced at year three on a five-year life, the life is the problem.
• Depreciating land. Land is not consumed, so it is not depreciated - though a building standing on it is.
• Omitting delivery and installation costs. They are part of the cost of getting the asset ready for use and belong in the depreciable amount.
• Running the schedule in an isolated spreadsheet. A depreciation tab with no link to who holds each asset or whether it still exists cannot be verified, only believed. That disconnect is exactly why spreadsheets fail for asset tracking.

Depreciation in an asset register

Depreciation is only as good as the asset data underneath it: purchase price, purchase date, and expected useful life recorded per asset, and disposals actually removed so ghost assets do not keep depreciating on paper. That is fixed asset register work as much as accounting work, and it is where most of the effort actually goes.

AMPthilly records purchase price and date, supplier, invoice number, warranty end date, expected useful life and replacement value on each asset record, with receipts and invoices attached to the asset so the evidence is not scattered across inboxes at year-end. Asset status changes, ownership transfers and field edits are logged in the audit history, so when something is retired there is a dated trail behind it. Asset valuation and depreciation is available as a module on the Pro plan, and CSV import and export mean finance can bring an existing schedule in and pull the figures straight back out.

FAQ

What is depreciation in simple terms? Depreciation spreads the cost of equipment over the years you use it, instead of charging the whole price in the year you bought it. A laptop that costs €1,200 and lasts four years shows up in the accounts as roughly €300 of expense per year, which matches the cost to the period that actually got the benefit. The asset’s recorded value falls by the same amount each time.

What is the most common depreciation method? Straight-line depreciation, because it is the simplest: cost minus salvage value, divided by useful life, giving the same expense every year. Declining-balance methods front-load the expense into the early years, which suits assets like IT equipment that lose value fastest when new. Units-of-production ties the expense to actual usage, such as machine hours, rather than to time.

Do all assets depreciate? No. Land is the classic exception - it is not used up, so it is not depreciated. Low-value items below an organisation’s capitalisation threshold are simply expensed when bought rather than depreciated, and consumables are never depreciated at all. Depreciation applies to fixed assets with a useful life beyond a year: equipment, vehicles, machinery, furniture, and buildings.

Is depreciation a cash expense? No. Depreciation is a non-cash expense. The money left the business when the asset was bought, which is the capital expenditure line; the annual charge is only an accounting entry spreading that earlier outflow across later years. Because no cash moves, depreciation is added back to profit in operating cash flow and is one of the letters added back in EBITDA, even though it does reduce reported and taxable profit.

When does depreciation start? When the asset is available for use in the condition and location intended, not on the invoice date and not when someone first switches it on. A machine installed, commissioned and ready to run starts depreciating even if production has not begun, and spare kit sitting in storage ready to deploy is already depreciating. For a mid-year purchase the first year is usually prorated: annual charge x months held / 12.

What happens when an asset is fully depreciated but still in use? Nothing further is charged. Once accumulated depreciation has taken the carrying amount down to salvage value, the expense stops, but the asset stays on the register at cost less accumulated depreciation until it is genuinely disposed of. Keeping it listed at nil or near-nil net book value is correct: it still exists, still needs a custodian, and still has to be found at audit.

How do you calculate depreciation for a part-year? Work out the full annual charge first, then prorate it: annual charge x months held / 12. A €4,800 machine on a four-year straight-line life charges €1,200 a year, so a purchase available for use on 1 October costs €300 in that first year and the schedule shifts three months into the final year. Some regimes simplify this with conventions such as a half-year charge in the year of acquisition.

Does depreciation reduce the value of an asset? Not in the market sense. Depreciation allocates cost across the years of use; it does not measure what the item would sell for. Net book value is an accounting figure produced by your chosen method and life estimate, so a fully depreciated van at nil book value can still fetch a real price, and a two-year-old laptop can be worth far less than its book value. For resale or insurance you need fair market value or replacement value instead.

The takeaway

Depreciation allocates what an asset cost across the years it is used - it does not measure what the asset is worth. Pick the method that matches how the asset is consumed, get the four inputs right (cost including installation, useful life, salvage value, start date), and the schedule follows mechanically. Remember that the charge is non-cash: it lowers profit and is added back in cash flow and EBITDA. Review the life and residual value annually rather than setting them once. And the part that actually goes wrong is never the arithmetic - it is not knowing whether the asset on line 47 still exists.

Related terms

• Straight-Line Depreciation - the equal-amounts-per-year method most teams use
• Declining-Balance Depreciation - the front-loaded alternative for fast-fading assets
• Depreciation Schedule - the year-by-year table the method produces
• Salvage Value - the estimated end-of-life value subtracted before depreciating
• Net Book Value - cost minus accumulated depreciation, the figure on the balance sheet
• Useful Life - the span the cost is spread across
• Amortisation - the same idea applied to intangible assets
• Impairment - the one-off write-down when an asset loses value unexpectedly
• Ghost Asset - the disposed item still depreciating on paper
• Asset Disposal - the step that stops the schedule and closes the lifecycle
• Fixed Asset Register - the record every depreciation calculation is built from
• CapEx - the capital purchase cost that depreciation spreads over time

Tools that make this easier

AMPthilly keeps the data a depreciation schedule depends on in one place: purchase price and date, supplier, invoice number, expected useful life, warranty end date and replacement value on each asset record, with receipts and invoices attached so nothing has to be reconstructed at year-end. Status changes and transfers are logged in the audit history, so retirements leave a dated trail instead of a silent ghost asset. Asset valuation and depreciation is available on the Pro plan, and CSV import and export let finance move schedules in and out. Start free - no credit card required - or talk to us about your setup.