Plain English guide to depreciation

Getting to grips with the basics of accounting, financial management and business strategy can be a challenge. To make things easier, we've created a plan-english guide to depreciation and the impact this accounting term can have on your assets, tax, cashflow and company accounts.

What is depreciation?

Depreciation is an accounting term that you’ll hear us talking about when we run your accounts.

In basic terms, depreciation is about allocating the cost of a tangible asset over the course of its useful life. These ‘tangible assets’ could be buildings, machinery, vehicles or equipment. Your profit & loss (P&L) account won’t be hit immediately for the whole cost of these assets. Instead the cost is spread out over their expected useful life. This is because the benefits of the asset are consumed over time, and its value decreases as it gets older or becomes obsolete.

For example: you might buy a delivery van for your coffee business, and drive it for the next five years. Each year, the value of the van will depreciate (and we’ll show that in your accounts).

How does depreciation affect your business?

As a business owner, it's important for you to understand depreciation and the effects it can have on your financial statements and the company’s tax planning.

Here are some the most important impacts of depreciation:

• Taxable income – depreciation is considered an operating expense. Unlike other expenses, though, depreciation isn't generally allowable for tax. Instead, there’s a system of capital allowances which cover tax deductions for fixed asset purchases.
• Cashflow – depreciation appears as an expense in your P&L account. But unlike most expenses, it’s a non-cash item. The cash leaves the business in a lump sum when you buy the fixed asset. Or the cash can leave over a longer period of time in the form of hire purchase or loan repayments. Depending on how/if the acquisition is financed, your cashflow can be better, worse or the same as the depreciation charge.
• Planning the replacement of assets – depreciation helps you understand which assets will soon need replacing, giving you time to put funds aside and plan for this expense.
• Better financial reporting – depreciation affects your balance sheet by reducing the value of assets over time, and your P&L statement by smoothing out the cost of fixed assets over time.

How can our firm help you with depreciation?

As your adviser, we’ll make sure that you’re always properly accounting for depreciation in your financial statement. This helps you maintain accurate financial records and makes decision-making easier when it comes to managing assets and forecasting future expenses.

We’ll also ensure you’re following the appropriate accounting principles and UK tax regulations related to the purchase and depreciation of your assets.