What is depreciation? Methods, examples and tax rules

Published Friday 20 March 2026

Table of contents

• What is depreciation?
• Why depreciation matters
• What can be depreciated?
• Methods of calculating depreciation
• Choosing a depreciation schedule
• How depreciation works for small businesses
• FAQs on depreciation

Key takeaways

• Recognize that depreciation is a real business expense that must be tracked on your income statement to accurately calculate profit and avoid overestimating your earnings.
• Utilize depreciation as a tax deduction to lower your tax bill by claiming the declining value of eligible fixed assets like equipment, computers, and vehicles over their useful life.
• Apply the straight line depreciation method for simplicity by dividing an asset's cost by its expected lifespan to determine annual depreciation amounts.
• Update your fixed asset register regularly to reflect depreciated values, as this affects your business valuation and ability to secure loans using assets as collateral.

What is depreciation?

Depreciation is what happens when a business asset loses value over time. A work computer, for example, gradually depreciates from its original purchase price down to $0 as it moves through its productive life.

If you buy a $1,500 laptop for your business and expect it to last three years, it would depreciate by $500 each year. After three years, its book value reaches $0.

There are techniques for measuring the declining value of those assets and showing it in your business's books. This area of accounting can get complex, so consider working with a professional.

Why depreciation matters

Depreciation accounting helps you in three key ways:

• Understand your true costs: Wear and tear is a real business expense
• Reduce your tax bill: Claim asset value loss as a deduction
• Estimate business value: Track how assets affect your net worth

Depreciation as an expense (cost of doing business)

Depreciation is a business cost because you eventually need to replace assets that wear down. To understand how profitable your business is, you need to account for this expense.

Depreciation accounting helps you figure out how much value your assets lost during the year. You need to list that number on your income statement and subtract it from your revenue when calculating profit.

If you don't account for depreciation, you'll underestimate your costs and think you're making more money than you really are.

You can download the free income statement template to work out all of your costs.

Depreciation and tax

Depreciation can lower your tax bill by allowing you to claim the declining value of assets as a deduction. For example, under Canadian tax rules, eligible businesses may be able to deduct the full cost of certain properties up to $1.5 million in a single tax year.

However, there are rules around how quickly you can depreciate certain assets from a tax perspective. Check with your tax office or accountant.

Valuing your business (depreciation on the balance sheet)

As assets lose value, so can your business. A transport company with old trucks may not be worth as much as a transport company with new trucks, for example.

You list your assets on your balance sheet in what's called the fixed asset register. Make sure you update the register whenever you work out depreciation.

You can often use assets to secure loans. As they drop in value, they offer less security, and you may find it more difficult to get finance.

You can download the free balance sheet template to help you keep track of your assets.

What can be depreciated?

Only fixed assets can be depreciated for most businesses. While most business expenses are tax-deductible, not all are depreciable.

The difference: you can deduct consumables like stationery from tax, but you have to claim them in the year you bought them. Fixed assets, on the other hand, depreciate over multiple years.

What are fixed assets?

A fixed asset is something that will help you generate income over more than a year. Common examples include:

• tools and machinery (the Canada Revenue Agency (CRA) often categorizes these under Class 8 with a capital cost allowance (CCA) rate)
• computers and office furniture
• vehicles
• buildings

You don't always have to own them. You may also be able to depreciate some leased items.

You can also depreciate (or amortize) intangible assets like patents and copyrights, with the CRA designating certain types of these expenditures as Class 14.1 property.

You can't depreciate some assets. Land doesn't lose value, so you can't depreciate it. You deal with inventory separately under inventory accounting.

Methods of calculating depreciation

Depreciation methods determine how an asset's value declines over its lifespan. Will it lose most of its value early, or will it lose value at the same rate every year?

There are many different methods of calculating depreciation, and some of them are quite complex. Three of the most common are:

Straight line depreciation

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

For instance, a $5,000 asset expected to last five years would depreciate by $1,000 each year.

Diminishing value depreciation

Diminishing value depreciation (also called declining balance) means an asset loses a higher percentage of its value in the first few years. That rate of depreciation gradually slows down as time goes on.

This method is useful when an asset is most productive early in its life, like technology that becomes outdated quickly. For instance, the CRA moved some manufacturing and processing equipment to a new class with a 50% declining-balance CCA rate to better reflect its value over time.

Units of production depreciation

Units of production depreciation measures an asset's lifespan by the work it does rather than the time it serves. You depreciate these assets based on usage rather than age.

This method works well for:

• vehicles measured by kilometres travelled
• machinery measured by units produced
• equipment measured by hours of operation

Choosing a depreciation schedule

A depreciation schedule determines how long you'll depreciate each asset. To depreciate an asset, you must first estimate its lifespan, which from a tax perspective, begins when the property becomes available for use; typically the date you first use it to earn income. A computer might only last three years. A kiln in a factory could last 30.

The tax office has depreciation schedules for common business assets. Most small business owners simply follow those recommendations.

You can adjust an asset's value to zero at any time if it's lost, stolen, or damaged. You can also sell, trade, or combine it into a new asset.

How depreciation works for small businesses

Depreciation doesn't have to be complicated for small businesses. It will help you better understand your costs and may lower your tax bill.

Most businesses simply adopt the depreciation schedule provided by the tax office. Once you set it up in your accounting software, the math happens automatically and the numbers flow straight through to your tax return.

An accountant or bookkeeper can advise you. And if you're looking for a simpler way to manage your finances, get one month free to see how Xero can help.

FAQs on depreciation

Here are some common questions to help you better understand how depreciation applies to your business.

What is an example of depreciation?

If you buy a $3,000 computer for your business and expect it to last three years, it would depreciate by $1,000 each year using straight line depreciation. After three years, its book value reaches $0, even though you may still use it.

Is depreciation good or bad for my business?

Depreciation is neither good nor bad. It's a standard accounting practice that helps you accurately track costs and can reduce your tax bill by spreading asset expenses over time.

How is depreciation different from a regular business expense?

You deduct regular expenses like office supplies fully in the year you buy them. Depreciation spreads the cost of larger assets over multiple years to match the period they help generate income.

What happens when I sell a depreciated asset?

When you sell a depreciated asset, you may have a gain or loss depending on the sale price compared to the asset's current book value. If you sell it for more than its book value, you may owe tax on the difference.

Do I need accounting software to manage depreciation?

You don't need software, but it makes depreciation much easier. Accounting software like Xero automatically calculates depreciation, updates your fixed asset register, and flows the numbers into your financial reports.