What is depreciation? A guide for Australian small businesses

Published Monday 15 June 2026

Table of contents

• What is depreciation?
• Purpose of depreciation: 3 main functions
• What can be depreciated?
• Methods of calculating depreciation
• How to calculate depreciation
• What is a depreciation schedule?
• ATO depreciation schedules and rates
• Record keeping for depreciation
• Simplify depreciation with Xero
• FAQs on depreciation

Key takeaways

• Depreciation spreads the cost of business assets over their useful life, giving you a more accurate picture of your true costs and profits.
• The ATO provides depreciation schedules and simplified rules for small businesses, including the instant asset write-off for items costing less than $20,000 in the 2025–26 income year.
• Choosing the right depreciation method, whether straight line, diminishing value or another approach, affects your tax deductions and financial reports each year.
• Accounting software like Xero can automate depreciation calculations and keep your asset register up to date, saving you time and reducing errors.

What is depreciation?

Depreciation is the accounting method used to spread the cost of a business asset over its useful life. As an asset ages and loses value through wear and tear, depreciation records that decline in your books.

A work laptop you buy for $2,000, for example, gradually depreciates from its purchase price down to $0 over its useful life. Each year, a portion of that cost is recognised as a business expense.

Depreciation matters because it gives you a clearer picture of what your business actually costs to run. Without it, you'd underestimate expenses and overestimate profits. This area of accounting can get complex, so it's worth working with a qualified accountant or bookkeeper.

Purpose of depreciation: 3 main functions

Depreciation accounting serves 3 key functions for your business: it tracks the true cost of doing business, supports legitimate tax deductions, and keeps your business valuation accurate.

Depreciation as an expense

Recording depreciation as a business expense reflects the reality that assets wear down and eventually need replacing. This makes depreciation a legitimate cost of doing business.

Each year, depreciation accounting calculates how much value your assets lost. This amount appears on your profit and loss statement and reduces your calculated profit. Without accounting for depreciation, you'll underestimate your true costs and overestimate your profits.

You can download a free profit and loss template to help work out all of your costs.

Beyond tracking costs, depreciation also plays a key role in reducing your tax bill.

Depreciation and tax

Tax depreciation allows you to gradually claim an asset's entire value as a tax deduction. For instance, small businesses can pool the business portion of higher-cost assets, claiming a 15% deduction in the first year and 30% in subsequent years.

There are a few important tax rules to keep in mind:

• Specific timing rules govern how quickly you can depreciate different asset types.
• Always consult your accountant or the Australian Taxation Office (ATO) for asset-specific depreciation rules.
• Following proper depreciation schedules ensures you maximise tax benefits legally.

Research from the Tax Foundation found that when inflation rises from 2% to around 5%, the investment costs businesses can recover through depreciation drop by up to 7.2 percentage points. In practical terms, higher inflation means your depreciation deductions buy less in real terms, making it even more important to claim every deduction you're entitled to.

Depreciation doesn't just affect your tax return; it also shapes how your business is valued.

Valuing your business

Asset depreciation directly impacts your business valuation. A transport company with new trucks is typically worth more than one with old trucks, and your balance sheet needs to reflect that difference.

Depreciation affects your balance sheet in several ways:

• Your fixed asset register lists all your assets and their current values on the balance sheet.
• Asset values should be updated each time you calculate depreciation.
• Keeping asset values current gives you a realistic picture of what your business is worth.

Depreciated asset values also affect your borrowing capacity. Banks often use assets as loan collateral, and depreciated assets provide less security for loans. Monitoring your asset values helps you anticipate any financing limitations.

Download a free balance sheet template to help you keep track of your assets.

What can be depreciated?

Not all tax-deductible expenses can be depreciated. There's an important difference between items you can claim immediately and those you depreciate over time.

Some expenses are deducted in full in the year of purchase:

• Consumables like stationery must be claimed in the year of purchase.
• Most day-to-day operating expenses are immediately deductible.
• These expenses are claimed once, in full, during the purchase year.

Only fixed assets that provide long-term business value can be depreciated over time.

What are fixed assets?

Fixed assets are items that help generate business income for more than 1 year. They include both physical and intangible assets.

Common physical fixed assets include:

• Equipment such as tools, machinery, computers and office furniture.
• Vehicles including cars, trucks and delivery vehicles. The ATO sets a limit on the value that can be depreciated for cars; the car limit for 2025–26 is $69,674.
• Buildings, but not land, which doesn't depreciate.
• Some leased items can also be depreciated.

Intangible assets can also be depreciated:

• Intellectual property such as patents, copyrights and trademarks.
• These assets lose value as they approach their expiry dates.
• The process for intangible assets is called amortisation, which works similarly to depreciation.

Some items cannot be depreciated at all:

• Land doesn't lose value, so it can't be depreciated.
• Inventory is handled separately under inventory accounting rules.

Methods of calculating depreciation

When you depreciate an asset, you need to decide how its value will decline over its lifespan. Will it lose most of its value early on, or will it lose value at a steady rate each year? There are several methods to choose from.

You only need to choose 1 method per asset. Here are 4 of the most common approaches.

Straight line depreciation

Straight line depreciation spreads the cost evenly across the asset's useful life. The asset depreciates by the same amount every year until it reaches zero value.

The formula is: (purchase price – salvage value) / useful life in years. For example, an asset costing $10,000 with no salvage value and a 5-year useful life would depreciate by $2,000 each year. This method is the simplest to calculate and the most widely used.

Not all assets lose value at a steady rate, so there are other approaches to consider.

Diminishing value depreciation

Under diminishing value depreciation, an asset loses a higher percentage of its value in the early years. The rate of depreciation gradually slows down over time because the percentage is applied to a shrinking base value.

This method is useful for assets that lose most of their value quickly, such as computers and technology equipment. The ATO allows either the straight line or diminishing value method for most depreciating assets.

For some assets, time isn't the best measure of value loss; usage is.

Units of production depreciation

The lifespan of some assets is better measured by the work they do than by the time they serve. A vehicle might travel a certain number of kilometres, or a packaging machine might process a certain number of products.

Units of production depreciation ties the expense directly to output. If a machine is rated for 100,000 units and produces 20,000 in a year, you'd depreciate 20% of its cost that year. This method works well when an asset's usage varies significantly from year to year.

If you want to claim even larger deductions in the early years, there's a fourth option.

Double-declining balance depreciation

Double-declining balance is an accelerated method that depreciates an asset at twice the straight line rate. Like diminishing value, it front-loads the expense so you claim larger deductions in the earlier years.

The formula takes the straight line rate (for example, 20% for a 5-year asset), doubles it to 40%, and applies that to the remaining book value each year. This method is common in international accounting standards and is useful for assets that lose value rapidly after purchase.

How to calculate depreciation

Seeing how each method works with real numbers makes it easier to compare them. Here are worked examples using Australian dollar amounts for a $10,000 asset with a 5-year useful life and no salvage value.

Straight line example

Annual depreciation = ($10,000 – $0) / 5 years = $2,000 per year. After year 1, the book value is $8,000. After year 2, it's $6,000. By the end of year 5, the asset is fully depreciated at $0. You claim the same $2,000 deduction every year.

The diminishing value method produces a different pattern of deductions.

Diminishing value example

Using a 40% diminishing value rate on the same $10,000 asset: in year 1 you'd claim $4,000 (40% of $10,000), leaving a book value of $6,000. In year 2, you'd claim $2,400 (40% of $6,000), leaving $3,600. Each year the deduction shrinks because you're applying the same rate to a smaller balance.

When depreciation is tied to output rather than time, the calculations look different again.

Units of production example

Say a $10,000 machine is rated for 50,000 units. The per-unit depreciation rate is $10,000 / 50,000 = $0.20 per unit. If the machine produces 15,000 units in year 1, the depreciation expense is 15,000 x $0.20 = $3,000. In a slower year with only 8,000 units, you'd claim $1,600.

The double-declining balance method uses the same asset but applies a more aggressive rate.

Double-declining balance example

The straight line rate for a 5-year asset is 20%. Doubled, that's 40%. In year 1: 40% of $10,000 = $4,000 (book value drops to $6,000). In year 2: 40% of $6,000 = $2,400 (book value drops to $3,600). The pattern is similar to diminishing value but specifically uses double the straight line rate as its starting point.

What is a depreciation schedule?

A depreciation schedule is a record that tracks how each of your assets depreciates over time. It lists every depreciable asset in your business, along with its purchase date, cost, useful life, depreciation method, annual depreciation amount and current book value.

Your depreciation schedule serves as the foundation for your tax deductions and financial reporting. It helps you see at a glance which assets are nearing the end of their useful life and may need replacing. Most accounting software, including Xero, can generate and maintain your depreciation schedule automatically.

ATO depreciation schedules and rates

The Australian Taxation Office (ATO) provides official depreciation schedules that set the effective life for most asset types. Using these schedules helps ensure your depreciation claims comply with tax law.

Different assets have vastly different useful lives. Computers typically last 3–4 years, vehicles usually last 5–8 years, and industrial equipment can last 20–30 years. The ATO publishes detailed tables for specific asset types, so you don't need to estimate useful life yourself.

Most small businesses follow ATO recommendations, especially if they're eligible for the simplified depreciation rules, which apply to businesses with an aggregated turnover of less than $10 million.

If an asset is lost, stolen or damaged, you can write its value down to zero. You can also sell, trade or combine assets into new assets.

Instant asset write-off

The instant asset write-off lets eligible small businesses claim an immediate deduction for assets costing less than a set threshold, rather than depreciating them over several years. For the 2025–26 income year, the threshold is $20,000 per asset.

This means if you buy a laptop for $1,800 or a piece of equipment for $15,000, you can deduct the full cost in the year of purchase instead of spreading it across several years. The asset must be first used or installed ready for use in the relevant income year.

The 2026–27 Federal Budget announced that the $20,000 instant asset write-off will be made permanent from 1 July 2026. Until that date, the threshold has been extended on a year-by-year basis.

For assets that exceed the write-off threshold, there's another simplified option.

Small business depreciation pool

Assets that cost $20,000 or more can be placed into a small business depreciation pool. In the pool, you claim a 15% deduction in the first year the asset is used or installed ready for use, and 30% of the pool's remaining balance in each subsequent year.

The pool simplifies tracking because you don't need to calculate depreciation separately for each higher-cost asset. All pooled assets are depreciated together at the same rate. If the pool balance falls below $20,000 at the end of an income year, you can write off the entire remaining balance.

The 5-year lock-out rule, which previously stopped businesses from re-entering the simplified depreciation regime after opting out, is suspended until 30 June 2026.

Record keeping for depreciation

Good record keeping is essential for claiming depreciation correctly and staying compliant with ATO requirements. Keeping accurate records also makes tax time much easier.

For each depreciable asset, you should keep:

• The date of purchase and the purchase price, including any receipts or invoices.
• The depreciation method chosen and the effective life used for calculations.
• Annual depreciation amounts claimed and the current written-down value.
• Records of any changes, such as improvements to the asset or partial business use.
• Details of disposal, including the date and sale price if the asset was sold.

The ATO requires you to keep these records for 5 years from the date you lodge your tax return. Storing records digitally in accounting software helps you stay organised and makes it straightforward to retrieve information if the ATO requests it. For more on keeping your finances in order, see the Xero guide to small business bookkeeping.

Simplify depreciation with Xero

Depreciation doesn't have to be complex. Once you understand the basics, most of the ongoing work can be automated. Most businesses simply adopt the depreciation schedule provided by the ATO, set it up in their accounting software, and let the calculations run from there.

The policy landscape around depreciation has shifted significantly in recent years. According to Reserve Bank of Australia research, the instant asset write-off threshold has moved from just $1,000 before 2012 to $20,000 in 2015, and reached uncapped levels during the COVID-19 full expensing period in 2021, before settling back to $20,000 for the 2025–26 financial year.

With Xero, depreciation calculations flow straight through to your financial reports and tax returns. You can also manage your fixed assets in one place, with automatic depreciation calculations and schedules. An accountant or bookkeeper can provide advice along the way, and you can get started today and Get one month free.

FAQs on depreciation

Here are answers to some frequently asked questions about depreciation.

What are the 4 main types of depreciation methods?

The 4 most common methods are straight line (even depreciation each year), diminishing value (more depreciation upfront), units of production (based on usage) and double-declining balance (twice the straight line rate, applied to the remaining balance). The best choice depends on the asset and how your business uses it.

What is the instant asset write-off threshold in Australia?

For the 2025–26 income year, eligible small businesses can instantly write off assets costing less than $20,000 each. The 2026–27 Federal Budget announced this threshold will be made permanent from 1 July 2026.

What is accumulated depreciation?

Accumulated depreciation is the total amount of depreciation that has been recorded against an asset since it was purchased. It appears on your balance sheet as a reduction to the asset's original cost, giving you the asset's current book value.

Can I change my depreciation method once I've started?

Generally, once you choose a depreciation method for an asset, you must stick with it. The ATO's 5-year lock-out rule that previously stopped businesses from re-entering the simplified depreciation regime is suspended until 30 June 2026, but it's still best to consult an accountant before making changes.

What records do I need to keep for depreciation?

For each depreciable asset, keep the purchase date, cost, depreciation method, annual amounts claimed and written-down value. The ATO requires you to retain these records for 5 years from the date you lodge the relevant tax return.

Do I need accounting software to manage depreciation?

You can use spreadsheets, but accounting software makes managing depreciation much easier. It automates calculations, reduces the risk of errors and keeps your asset register up to date, saving you time and helping you stay compliant.