Depreciation methods explained, with a full worked schedule

Depreciation allocates the cost of a long-lived asset, less what you expect to get back at the end, over the period the business uses it. It isn't a way of valuing the asset, and it isn't saving cash for a replacement. It's matching: a delivery van that earns revenue for four years should be expensed over those four years, not all in the year it was bought.

This guide uses one asset throughout so you can compare the methods directly.

What you need before you start

• Cost — the purchase price plus costs directly attributable to getting the asset ready for use: delivery, installation, testing, professional fees and, where there's an obligation, the estimated cost of dismantling and restoring the site. Trade discounts are deducted. Ongoing running costs, training and general overheads are expensed.
• Residual value — the amount the business would expect to receive now for the asset if it were already at the age and condition expected at the end of its useful life, after disposal costs.
• Useful life — the period (or units of output) over which the business expects to use the asset. This is an entity-specific judgement, which may be shorter than the asset's physical life.
• Depreciable amount — cost less residual value.
• Date available for use — depreciation starts when the asset is available for use, not when it's paid for or first used heavily.

Under IAS 16 the residual value, useful life and method are reviewed at least at each financial year-end, and depreciation stops when the asset is derecognised or classified as held for sale.

The asset: Orrin Logistics' delivery van

Orrin Logistics has a 31 December year-end. On 1 April 2026 it buys a delivery van:

The first year's insurance (1,200) is a running cost, expensed over the period of cover, and isn't part of cost. Orrin expects to use the van for four years and 160,000 km, then sell it for about 4,000. The depreciable amount is 36,000 − 4,000 = 32,000.

Straight-line

The depreciable amount is spread evenly: 32,000 ÷ 4 = 8,000 a year, or 666.67 a month. The van is available from 1 April 2026, so 2026 carries nine months: 8,000 × 9 ÷ 12 = 6,000. The last three months fall in 2030.

Straight-line suits assets whose benefits are used up roughly evenly over time — buildings, office furniture, many types of equipment.

Reducing balance

A fixed percentage is applied to the opening carrying amount each year, so the charge is highest in the early years. Here Orrin uses double the straight-line rate: 2 × 25% = 50%. The residual value isn't deducted before applying the rate, but the carrying amount is never depreciated below it.

In 2029, 50% of 5,625 would be 2,812.50 and would take the carrying amount to 2,812.50 — below the 4,000 residual value — so the charge is limited to 1,625. Reducing balance suits assets that lose most of their usefulness early, such as vehicles and technology. Some businesses switch to straight-line in later years; either way the total depreciated never exceeds the depreciable amount.

Units of production

Depreciation follows usage: 32,000 ÷ 160,000 km = 0.20 per km.

No part-year proration is needed: usage already reflects the time in service. This method suits assets that wear out with use — machines measured in operating hours, vehicles measured in distance. IAS 16 does not allow depreciation based on the revenue an asset generates, because revenue reflects prices and other factors besides the consumption of the asset.

You can build all three schedules side by side, with your own figures, in the depreciation schedule builder.

Recording depreciation

Each period: debit Depreciation expense, credit Accumulated depreciation. Accumulated depreciation is a contra-asset that keeps the original cost visible in the ledger. For the straight-line 2026 charge: debit Depreciation expense 6,000, credit Accumulated depreciation — vehicles 6,000. Depreciation is non-cash, which is why it's added back in an indirect cash flow statement.

Changes in estimates

If useful life, residual value or the pattern of use changes, the change is a change in accounting estimate: apply it from now on (prospectively). Don't restate prior years.

Example. On 1 January 2028, under straight-line, the van's carrying amount is 22,000. Heavy use means Orrin now expects to sell it at 31 December 2030 for 2,500. Remaining life: three years. New annual depreciation = (22,000 − 2,500) ÷ 3 = 6,500 for 2028, 2029 and 2030. Depreciation already recorded in 2026 and 2027 is left unchanged.

Disposals

When an asset is sold or scrapped:

1. Depreciate it up to the date of disposal.
2. Remove its cost and accumulated depreciation.
3. Record the proceeds.
4. Recognise the difference between proceeds and carrying amount as a gain or loss on disposal in profit or loss (not as revenue).

Example. Under straight-line, Orrin sells the van on 30 June 2028 for 15,500. Depreciation for January to June 2028 is 8,000 × 6 ÷ 12 = 4,000, so accumulated depreciation is 6,000 + 8,000 + 4,000 = 18,000 and the carrying amount is 36,000 − 18,000 = 18,000. Proceeds of 15,500 give a loss of 2,500.

Debits 15,500 + 18,000 + 2,500 = 36,000 = credits. The asset disposal calculator lets you rerun this with different dates and proceeds.

IFRS and US GAAP points to know

• Components. IAS 16 requires each part of an asset with a cost that's significant in relation to the total to be depreciated separately if its useful life differs — for example an aircraft's engines and its airframe. US GAAP permits component depreciation but doesn't require it.
• Revaluation. IFRS allows a class of property, plant and equipment to be carried at revalued amounts, with depreciation based on the revalued figure. US GAAP doesn't permit upward revaluation of property, plant and equipment.
• Impairment. Depreciation isn't a test of value. If there are signs an asset is worth less than its carrying amount, an impairment review is needed; see the impairment lesson.
• Tax. Tax depreciation (capital allowances) often follows different rules and rates. The difference between the accounting carrying amount and the tax base gives rise to deferred tax — covered in the deferred tax lesson.

Common mistakes

• Starting depreciation when the asset is paid for rather than when it's available for use, or ignoring part-year proration.
• Deducting residual value before applying a reducing-balance rate, or depreciating below residual value.
• Capitalising running costs such as insurance and routine servicing.
• Restating prior years when an estimate changes.
• Forgetting to depreciate up to the disposal date, which misstates the gain or loss.
• Recording disposal proceeds as revenue.

Frequently asked questions

Is land depreciated?

Normally not, because it generally has an unlimited useful life. When land and a building are bought together, they are separated and only the building is depreciated.

Does depreciation provide cash for replacing assets?

No. It's an allocation of cost that has already been paid. It reduces profit, not cash.

Which method gives the "right" answer?

The one that best reflects the pattern in which the asset's benefits are consumed. All three methods depreciate the same 32,000 in total; they differ only in timing.

Practise it

Start with recognising property, plant and equipment, then the graded depreciation methods and disposals lessons, which include schedule tables to complete. The Year-End Closing case asks you to post the depreciation and close the books, and the Month-end accountant pathway covers fixed assets as part of the monthly routine.