Depreciation explained: what it is, how it is calculated, and what it does not tell you
Depreciation is the accounting method that spreads the cost of a vehicle, machine, or other fixed asset across the years it is expected to earn its keep, writing down its book value each period instead of charging the whole purchase price to the year it was bought. It is cost allocation, not valuation, and confusing the two causes most of the arguments it starts.
The word carries several senses on the same asset. Book depreciation sits in the management accounts. Tax depreciation is a separate calculation with its own rulebook. Amortisation is the same idea applied to intangibles, and impairment is a one-off write-down, not a schedule.
What does depreciation mean on a fleet or plant register?
Three inputs decide the entire schedule, and all three are estimates made on day one.
- Cost. Purchase price plus everything needed to get the asset into use: delivery, commissioning, tipper body, crane fit, livery, telematics hardware.
- Useful life. How long this business expects to run it, which is a different question from how long it could physically last.
- Residual value. What it should be worth at the end of that life. On a fleet this is the number that moves most and gets revisited least.
Depreciable amount is cost minus residual value. Under IAS 16, residual value, useful life and method are reviewed where expectations have changed significantly, and the charge keeps running even in a year when the asset's fair value has risen (IFRS, IAS 16).
How is depreciation calculated? The four methods you will actually meet
Take a rigid truck bought for 90,000, expected to run six years, with an estimated residual of 15,000. The depreciable amount is 75,000.
- Straight line. 75,000 divided by six gives 12,500 a year, every year. Predictable, and it assumes the loss is even, which it never is.
- Reducing balance. A fixed rate applied to the carrying amount. At 25 percent that is 22,500 in year one, then 16,875 on the remaining 67,500, then 12,656. Front-loaded, so it tracks the used market more closely.
- Sum of the years' digits. With a six-year life the digits total 21, so year one takes 6/21 of 75,000, or 21,429, and the charge steps down after.
- Units of production. Tie the charge to output instead of the calendar. Across an expected 600,000 km, 75,000 is 0.125 per km, so a 90,000 km year costs 11,250 and a quiet year costs less.
A worked example: one truck, two methods, one awkward conversation
After twelve months, straight line leaves that truck on the books at 77,500. Reducing balance at 25 percent leaves it at 67,500. Nothing about the truck is different. Sell it in month 13 for 70,000 and one set of accounts records a loss on disposal while the other records a profit, decided by a policy choice made before the vehicle was delivered.
Tax depreciation is a separate calculation
Revenue authorities rarely accept the management-accounts figure, so two schedules run in parallel for the life of the asset. In the United States, IRS Publication 946 places automobiles and light trucks in the five-year MACRS property class, depreciated on the 200 percent declining balance method with a half-year convention unless the mid-quarter convention applies (IRS Publication 946). In the United Kingdom, book depreciation is added back entirely and capital allowances are claimed instead: an annual investment allowance of up to 1 million pounds on qualifying plant and machinery, then a main-rate writing down allowance of 18 percent on a reducing balance, or 6 percent for special-rate assets such as long-life items and higher-emission cars (GOV.UK, rates and pools). A cut in that main rate to 14 percent has been legislated for, so confirm the rate for the period you are filing.
Where book value and market value part company
This is the honest limit. A depreciation schedule is a policy decision made once and then applied mechanically. The used market is a live auction that never saw your policy.
The published estimates do not even agree with each other. Experian puts the average first-year loss on a new car at around 16 percent, while other widely quoted figures land between roughly 12 and 20 percent (Experian). That spread is the useful part. No formula tells you what your asset is worth on the day you sell it.
Condition and paperwork widen the gap further. A machine with a full service history and current examination certificates sells for more than an identical machine with a hole in its records. None of that appears in the depreciation calculation, and all of it appears in the hammer price.
How depreciation gets misread
- Treating book value as a selling price. Market value, insured value, replacement cost and carrying amount are four numbers built for four different purposes.
- Calling it a non-cash cost and stopping there. No money leaves the account this month. The replacement it is quietly funding is very much a cash event.
- Leaving residual assumptions untouched. A residual set before a shift in the used-equipment market can be years out of date, and nobody finds out until disposal day.
- Reading "fully depreciated" as "finished". An asset at zero book value can be the most productive thing on site. It can also be the thing quietly failing its examinations.
- Comparing operators on different policies. Straight line against reducing balance is not a like-for-like cost per hour, and neither is a five-year life against eight.
Depreciation is one line in the cost of owning an asset, next to fuel, maintenance, downtime and the asset utilisation rate that decides how much work the charge gets spread across. It belongs alongside the plant and machinery register and the fleet management plan, not in a spreadsheet of its own. At disposal, dated equipment verification evidence of what the asset actually looks like is worth more than the carrying amount ever was.