Absolutely noth… well, actually, quite a lot! When you have a fixed asset in your company it will most likely suffer from depreciation. So, what is depreciation? You know when you buy a brand new car and the second you drive it off the forecourt it’s no longer worth what you paid for it? That is depreciation. The value of the car has depreciated and can no longer be classed as being worth the same amount in your books.

Now normally depreciation wouldn’t happen 5 minutes after you’ve bought something, it’s more likely that you’ll buy some equipment for example and it’ll wear out over the span of a few years. To have an accurate view of the value of the asset in our accounts we have to work out the depreciation every year. There are a few ways of working it out and I’ll demonstrate two of the most common ones below:

Straight Line Depreciation

Description: The amount of depreciation is the same, year on year.

Method: Let’s say you bought a van costing £15,000. You’ve decided to keep it for 5 years and you reckon you could sell it for £5,000 after the 5 years is up. To work out the depreciation you take the starting value and subtract the end value, then divide by the number of years. £15,000 – £5,000 = £10,000 / 5 = £2000. So the depreciation you would enter into your accounts each year is £2,000.

Now you could decide instead that the van will be worthless after 5 years, in which case the amount of depreciation each year will be worked out by £15,000 / 5 = £3,000.

Reducing Balance Depreciation

Description: The amount of depreciation is based on the new value of the asset each year.

Method: For this method you need to choose a percentage to depreciate the asset by and that percentage stays the same every year. Say you bought a machine costing £10,000 and you’ve decided it will lose 5% of its value every year. After the first year the depreciation will be 5% of £10,000 = £500. After the second year you need to use the new value of the machine to work out the depreciation, £10,000 – £500 = £9,500. The depreciation for the second year will be 5% of £9,500 = £475. This keeps going every year until you get rid of the machine. The value of the machine will never be zero using this method.

It can seem confusing but once you’ve got the hang of either method you’ll be alright! The most important thing to remember here is consistency. Once you’ve chosen a depreciation method you can’t change to use the other one, so choose wisely padawan!