Depreciation in small company accounts – and why it matters

If your limited company buys equipment, it may need to be recorded as a fixed asset rather than a normal business expense.

This commonly applies to items such as laptops, office furniture, mobile phones and other equipment which will be used for more than a year.

Instead of charging the full cost to the profit and loss account immediately, the asset is written down over its useful life using depreciation.

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 in your accounts, 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 ordinary 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

There is no HMRC-set minimum value at which an item must be treated as a fixed asset. In practice, companies and their accountants normally set a capitalisation threshold based on materiality and the company’s accounting policy, so relatively inexpensive items may simply be charged to the profit and loss account.

Once an item qualifies, it is added to your fixed asset register and depreciated over time.

The exact accounting treatment depends on the standard your company uses. Many small contractor companies prepare micro-entity accounts under FRS 105, while others use FRS 102.

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, tax relief is normally given through capital allowances.

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. This is applied in your tax computation, not your bookkeeping software.

Companies may also be able to claim full expensing, which provides a 100% first-year deduction for qualifying new and unused main-rate plant and machinery.

A further 40% first-year allowance is available for qualifying new and unused main-rate plant and machinery from 1 January 2026.

There are also Writing Down Allowances, used when the asset does not qualify for full relief or where the company chooses not to claim the full amount available upfront.

From 1 April 2026, the main Corporation Tax writing-down allowance rate is 14%. The special-rate pool remains at 6%. Special rules also apply to 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 some or all of the capital allowance claim until a future year.

This may sometimes be useful, as it can preserve allowances for a later period when the company has taxable profits.

You do not have to claim the maximum allowance available straight away. In some cases, your accountant may decide that leaving some relief for a later year makes more sense.

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 is basically the running record of what fixed assets the company owns and how they are being depreciated.

Your accountant may keep the register separately or maintain it within your bookkeeping software. HMRC may also ask to see it as part 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.

Keep the invoices and purchase details for any assets bought by the company and make sure your accountant knows about them. They can then deal with the depreciation in the accounts and claim the appropriate capital allowances in the tax return.

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