Depreciation in small company accounts – and why it matters

If you buy equipment through your limited company, such as a laptop, office chair or mobile phone, you usually can’t claim the full cost as a day-to-day expense. Instead, it’s recorded as a fixed asset and written down in value over time using depreciation.

This is an accounting concept only, but it has a direct impact on how your accounts are presented and how your tax is calculated. Here’s what contractors and small business owners need to know.

What is depreciation?

Depreciation is a method used in accounting to reflect how an asset loses value over time.

Rather than claiming the entire cost of an item upfront, your accountant spreads that cost across the number of years the item is expected to be useful.

This helps match the cost of the asset with the revenue it helps generate.

For example, if your company buys a £1,500 computer and it is expected to last for three years, the business would typically depreciate it by £500 per year using the straight-line method. This appears as a non-cash expense in your profit and loss report.

Where does depreciation appear in your accounts?

In your accounting software, such as FreeAgent, fixed assets are recorded on the balance sheet, not as business expenses.

As depreciation is applied, a portion of the asset’s value is moved from the balance sheet to the profit and loss account each year as a depreciation charge.

This reduces your reported profit but not your taxable profit. Depreciation is a common entry under ‘overheads’ in your P&L. You can see FreeAgent’s help guide here.

What counts as a capital asset?

HMRC generally treats an item as a capital asset if it is expected to last more than one year and is not consumed immediately in the course of business. Typical examples include:

• IT equipment
• Office furniture
• Mobile phones
• Vehicles
• Tools or machinery

The minimum value at which an item is treated as an asset rather than an expense varies by accountant but is often between £100 and £500.

Once an item qualifies, it is added to your fixed asset register and depreciated over time. This ensures your accounts comply with UK accounting standards such as FRS 105.

How depreciation is calculated

There are two common ways to depreciate assets:

• Straight-line depreciation. This method divides the cost of the asset equally over its expected useful life. It’s simple and widely used.
• Reducing balance depreciation. This method applies a fixed percentage to the remaining value of the asset each year, resulting in higher charges in the earlier years and smaller charges later.

Your accountant will select the method based on the type of asset and standard accounting practice. In most small company accounts, straight-line depreciation is the default.

Why depreciation is not tax-deductible

Although depreciation appears as a cost in your profit and loss account, HMRC does not allow it as a deduction for Corporation Tax purposes.

Instead, you must claim capital allowances, which are calculated separately and follow specific tax rules.

This means your profit in your statutory accounts may differ from your taxable profit. See HMRC’s overview of capital allowances.

How capital allowances work

Capital allowances allow your company to claim tax relief on the cost of qualifying assets.

The most common form is the Annual Investment Allowance (AIA), which allows you to deduct 100% of the cost of qualifying plant and machinery (including IT equipment) from your profits in the year of purchase, up to a limit of £1 million per year (for 2025/26). This is applied in your tax computation, not your bookkeeping software.

There are also Writing Down Allowances, used when the asset does not qualify for full relief under AIA, and special rules for cars.

The capital allowance system is separate from depreciation.

Your accountant will prepare a schedule to adjust for this when completing your Corporation Tax return (CT600). Full HMRC guidance here.

Deferring capital allowances

If your company has made little or no profit in the year an asset is purchased, your accountant may advise deferring the capital allowance claim until a future year.

This can be more tax-efficient, as it offsets tax when it is actually due.

There is no obligation to claim capital allowances in the same year the asset is bought, giving your business some flexibility in tax planning.

What is a fixed asset register?

A fixed asset register is a record of all capital assets held by your company, including purchase date, description, cost, expected useful life, and depreciation method.

It supports both accounting and tax purposes and should be updated regularly. Your accountant may keep this on file or manage it within your bookkeeping software. It may be requested by HMRC in the event of an enquiry.

Your responsibilities as a director

As a company director, you are responsible for keeping accurate financial records. This includes ensuring that all assets are properly recorded, categorised, and depreciated.

Make sure your accountant has the correct information and supporting invoices for all purchases. You should also check that depreciation and capital allowances are being handled appropriately in your year-end accounts.

Summary

• Depreciation spreads the cost of an asset over its useful life for accounting purposes
• It appears in your profit and loss account but is not tax-deductible
• Instead, you claim capital allowances such as the AIA when calculating Corporation Tax
• Depreciation is visible in your accounts and software like FreeAgent but does not reduce your taxable profit
• Keep good records and speak to your accountant about the most efficient treatment of any asset purchases