What is straight-line depreciation?

What straight-line depreciation means

Depreciation spreads the cost of a fixed asset over the years it is used. The straight-line method charges an equal amount each year:

Annual depreciation = (cost − residual value) ÷ useful life in years

The residual value is what you expect the asset to be worth at the end of its life. Some businesses express the charge as a percentage of cost instead, for example 20% a year for five years. Straight-line suits assets that are used fairly evenly over their life, such as furniture, fixtures, shop fit-outs and buildings.

Example

A plumbing business buys a van for £24,000. It expects to keep it for five years and sell it for £4,000.

Each year £4,000 is charged to the profit and loss account, and the van's value on the balance sheet falls by the same amount.

Partial years and disposals

Businesses choose a policy for assets bought part-way through the year: some charge a full year's depreciation in the year of purchase and none in the year of sale, others charge it month by month. When an asset is sold, any difference between the sale price and its book value is shown as a profit or loss on disposal. If the van in the example sold for £6,000 at the end of year five, there would be a £2,000 profit on disposal.

Why it matters for your business

Depreciation gives a fairer picture of profit than charging the whole £24,000 in the year of purchase. But it is an accounting entry, not a tax deduction. When working out taxable profit, depreciation is added back and capital allowances are claimed instead. A van normally qualifies for the Annual Investment Allowance, so the plumber could deduct the full £24,000 for tax in year one while the accounts show £4,000 a year. Cloudkeepers sets sensible depreciation policies when preparing clients' accounts.

Straight-line vs reducing balance

Reducing balance depreciation charges more in the early years and less later, which suits assets that lose value quickly, such as computers and cars.