What is depreciation and how is it calculated?
Answered 17 March 2026
I now have sufficient information to provide a comprehensive answer. Note that the question "What is depreciation and how is it calculated?" is primarily an accounting concept. The retrieved sources address it from a UK tax perspective — specifically that depreciation is not an allowable tax deduction, with capital allowances substituting for it.
Depreciation: Definition, Calculation, and UK Tax Treatment
What the law says
The retrieved legislative sources do not contain a statutory definition of depreciation itself, as it is an accounting concept rather than a legal one. However, legislation does address how depreciation adjustments interact with tax calculations — for example, where there is a change of basis affecting amounts brought into account in respect of depreciation, any resulting receipt or expense is treated as arising only when the asset to which it relates is realised or written off.
HMRC Guidance / Practice
What is depreciation?
Depreciation is an accounting charge that reflects the reduction in value of business assets (such as motor cars, vans, fittings and fixtures) with age and use. It is charged so that each year the correct cost to the business is identified and an appropriate sum is set aside, by a deduction from profits, for their replacement.
How is it calculated?
A common method of calculating the annual depreciation allowance is to spread the cost of the asset over the period of its expected useful life, after deducting its estimated scrap or disposal value. This is known as the straight-line method.
HMRC guidance notes that GAAP does not require entities to use a straight-line depreciation policy, though that would normally be the case. Other methods exist, such as the diminishing/reducing balance method and the production method. For example, under straight-line depreciation, an asset costing £6,000 with a 6-year life would depreciate at £1,000 per year.
In accounts, depreciation is recorded as a debit to the profit and loss account and a credit to an accumulated depreciation account.
Critical UK Tax Point — Depreciation is NOT an allowable deduction
For UK tax purposes, depreciation of a capital asset is not an allowable deduction when computing profits or losses. This follows from the basic principle that income tax excludes capital items. Depreciation charged in the accounts is therefore added back in the tax computation.
Instead, capital allowances may be available to the owner of qualifying assets as the tax equivalent of depreciation. For tax purposes, there is no deduction for depreciation, but the trader may claim capital allowances on plant and machinery. Depreciation and capital allowances cannot both be deducted in respect of the same asset.
Citation sources
In the next accounting period a unitary payment of £15m is receivable in respect of the additional prison places. For accounting purposes the whole of the unitary payment is credited to the profit and loss account. Depreciation on the fixed asset, calculated at £3m, is debited to the profit and loss account. - - Amount - - Amount Dr Bank £15m Cr P&L account £15m Dr P&L account (depreciation) £ 3m Cr Accumulated depreciation account £ 3m For tax purposes we follow the accounting recognition of in
In the second accounting period the trade commences and a unitary payment of £15m is receivable. For tax purposes the £15m is trading income for the provision of services. For accounting purposes the whole of the unitary payment is credited to the profit and loss account. Depreciation on the fixed asset, calculated at £3m, is debited to the profit and loss account. - - Amount - - Amount Dr Bank £15m Cr P&L account £15m Dr P&L account (depreciation) £ 3m Cr Accumulated depreciation account £ 3m F
Business assets (for example motor cars, vans, fittings and fixtures) normally reduced in value with age and use. An allowance was made for depreciation so that each year the correct cost to the business was identified and an appropriate sum set aside, by a deduction from profits, for their replacement. A common method of calculating the annual allowance was to spread the cost of the item over the period of its expected useful life after deducting its estimated scrap or disposable value. Notes t
GAAP does not require entities to use a straight-line depreciation policy, though that would normally be the case. However, there are variants on straight-line depreciation that do not mirror the rules for taxing long funding operating leases. Example 1 An asset has an expected economic life of six years and is acquired by a lessor for £6000. It is leased under a four year operating lease at an annual rental of £1500. The lessor estimates that its value at the end of the lease will be £2000. The
prudent basis, of the UEL should be made but that does not form the grounds for choosing an unrealistically short UEL. (7) FRS 10 also states that ‘Whilst uncertainty forms grounds for estimating the [UEL] on a prudent basis, it does not form the grounds for choosing a life that is unrealistically short.’ (8) They referenced PriceWaterhouseCoopers’ Manual of Accounting UK GAAP 2012 which says in that regard that: ‘A long life [for an intangible asset] (20 years plus) will generally require a bus
This manual is being updated to reflect FRS 102 (2024 amendments). For guidance on the tax treatment of accounts prepared under IFRS 16 or the revised FRS 102, please refer to pages within the BLM50000 chapter. The tax treatment of an operating lessor’s rentals follows GAAP unless the lease is a long funding lease of plant or machinery (outline at BLM00550 and detail at BLM20000), in which case the tax treatment is very different (BLM40000 onwards). Generally accepted accounting practice recogni