What is depreciation? Methods, examples, and tax rules

Published Wednesday 27 May 2026

Table of contents

• What is depreciation?
• Why depreciation matters
• What can be depreciated?
• Methods of calculating depreciation
• Comparing depreciation methods
• Book depreciation vs. CCA (tax depreciation)
• How to record depreciation
• How depreciation works for small businesses
• Simplify your asset tracking with Xero

Key takeaways

• Depreciation spreads the cost of a business asset across its useful life, giving you a more accurate picture of your true costs and lowering your taxable income each year.
• In Canada, the Canada Revenue Agency (CRA) uses Capital Cost Allowance (CCA) classes to set the rates at which you can claim tax depreciation, and these rates may differ from the depreciation you record in your books.
• Five common methods exist for calculating depreciation: straight-line, declining balance, double-declining balance, sum-of-years' digits, and units of production. Most Canadian small businesses follow the CCA rates that apply to their asset class.
• Recording depreciation correctly keeps your financial statements accurate, helps you plan for asset replacements, and ensures you claim the deductions you're entitled to at tax time.

What is depreciation?

Depreciation is the process of spreading the cost of a business asset over its useful life. Instead of recording the full purchase price as an expense in the year you buy it, you allocate a portion of the cost to each year the asset helps generate income.

For example, if you buy a $1,500 laptop for your business and expect it to last three years, it would depreciate by $500 each year using the straight-line method. After three years, its book value reaches $0, even though you may still be using it.

There are several methods for measuring how quickly an asset loses value, and Canadian tax rules have their own system called Capital Cost Allowance (CCA). The basics are straightforward, but the details can get complex, so consider working with an accountant or bookkeeper when setting up depreciation for the first time.

Why depreciation matters

Depreciation affects how you track costs, file taxes, and understand what your business is worth. Getting it right gives you a clearer view of your finances and helps you make better decisions.

Depreciation as an expense

Assets like vehicles, equipment, and computers wear down over time, and you eventually need to replace them. Depreciation accounts for that ongoing cost so your financial records reflect what your business is actually spending.

Each year, you list the depreciation amount on your income statement and subtract it from your revenue when calculating profit. If you skip this step, you overestimate your earnings and may not set aside enough for replacements.

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 your assets as a deduction. In Canada, the CRA uses Capital Cost Allowance (CCA) to determine how much you can deduct each year, based on the class your asset falls into.

Some assets qualify for accelerated first-year deductions, which means you can claim a larger portion of the cost sooner. The rules around how quickly you can depreciate certain assets change from time to time, so check with your accountant or the CRA for the latest rates. Understanding how depreciation fits into the bigger picture of small business tax rates in Canada can also help with planning.

Valuing your business

As your assets lose value, so can your business. A delivery company with a fleet of aging vehicles may not be worth as much as one with newer trucks, for example.

You list your assets on your balance sheet in what's called a fixed asset register. Keeping that register updated as you record depreciation helps you see your business's true net worth at any point in time. Xero's fixed asset management tools can help you stay on top of this.

Lenders also consider asset values when reviewing loan applications. As assets drop in value, they offer less security, and it may become harder to secure financing.

What can be depreciated?

Only certain types of assets can be depreciated. Understanding which ones qualify helps you claim the right deductions and keep your records accurate.

What are fixed assets?

A fixed asset is something your business owns that will help generate income over more than one year. Common examples include:

• Tools and machinery (the CRA often categorizes these under Class 8 with a 20% CCA rate)
• Computers and office furniture
• Vehicles
• Buildings

You don't always have to own an asset outright. In some cases, you may also be able to depreciate leased items if the lease terms transfer most of the risks and rewards of ownership to you.

What cannot be depreciated?

Not every business asset qualifies for depreciation. Knowing what falls outside the rules helps you avoid errors on your tax return.

Land does not lose value through wear and tear, so it cannot be depreciated. If you buy a property that includes both land and a building, only the building portion is depreciable.

Intangible assets such as patents, copyrights, and trademarks are not depreciated either. Instead, they are amortized, which is a similar process but applies specifically to non-physical assets. The CRA classifies many intangible assets under Class 14.1 for CCA purposes.

Inventory is also handled separately under inventory accounting rules and cannot be depreciated.

Methods of calculating depreciation

Depreciation methods determine how an asset's cost is spread over its useful life. Some methods allocate the same amount each year, while others front-load the expense so you claim more in the early years. Here are five 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 its salvage value (or $0 if there is no salvage value).

The formula is: (Cost - Salvage value) / Useful life = Annual depreciation.

For example, a $5,000 piece of equipment with no salvage value and a five-year useful life would depreciate by $1,000 each year. This method is the simplest to calculate and works well for assets that lose value steadily over time.

Declining balance depreciation

Declining balance depreciation applies a fixed percentage to the asset's remaining book value each year. Because the book value shrinks, the depreciation amount decreases over time.

This method is useful when an asset is most productive early in its life, like technology that becomes outdated quickly. It also aligns closely with how the CRA calculates CCA, since most CCA classes use a declining balance rate. For instance, Class 50 computer hardware uses a 55% declining balance rate.

Double-declining balance depreciation

Double-declining balance (DDB) depreciation is an accelerated method that depreciates assets at twice the straight-line rate. It front-loads the expense heavily into the first few years.

The formula is: 2 x (1 / Useful life) x Book value at start of year = Annual depreciation.

For a $10,000 asset with a five-year useful life, the straight-line rate would be 20% per year. Doubling it gives a 40% DDB rate.

In the first year, depreciation would be $4,000 (40% of $10,000). In the second year, it would be $2,400 (40% of the remaining $6,000). The expense continues to shrink each year.

DDB is helpful for assets that lose most of their value early, such as vehicles or certain technology. You stop depreciating once the book value equals the salvage value.

Sum-of-years' digits depreciation

Sum-of-years' digits (SYD) is another accelerated method. It assigns a larger fraction of the depreciable cost to the earlier years and a smaller fraction to later years.

To use SYD, first add up all the years of the asset's useful life. For a five-year asset, that sum is 5 + 4 + 3 + 2 + 1 = 15. In year one, you depreciate 5/15 of the depreciable cost; in year two, 4/15; and so on.

For a $10,000 asset with no salvage value and a five-year life, the first-year depreciation would be $3,333 (5/15 x $10,000), and the second-year amount would be $2,667 (4/15 x $10,000). SYD gives a more gradual acceleration than DDB.

Units of production depreciation

Units of production depreciation measures an asset's life by the work it does rather than the time it serves. You depreciate based on actual usage instead of a calendar schedule.

This method works well for:

• Vehicles measured by kilometres driven
• Machinery measured by units produced
• Equipment measured by hours of operation

For example, if a machine costs $50,000, has no salvage value, and is expected to produce 100,000 units, each unit carries $0.50 of depreciation. In a year where the machine produces 20,000 units, you would record $10,000 in depreciation.

Comparing depreciation methods

Choosing the right depreciation method depends on the type of asset, how you use it, and your financial goals. Here's a summary to help you compare.

• Straight-line. Best for assets that lose value evenly over time, such as office furniture. It produces consistent annual expenses and is the simplest to calculate.
• Declining balance. Best for assets that are most productive early in their life, such as computers. It closely mirrors how the CRA calculates CCA for most asset classes.
• Double-declining balance. Best when you want to claim larger deductions in the first few years. Useful for vehicles and technology that lose value quickly.
• Sum-of-years' digits. Similar to DDB but with a gentler acceleration curve. Useful when you want front-loaded deductions without as steep a drop-off.
• Units of production. Best for assets whose wear depends on usage rather than time, such as manufacturing equipment or delivery vehicles.

In Canada, the CRA determines how you depreciate assets for tax purposes through the CCA system. You select a CCA class for each asset, and the class sets the rate. For your internal books, you can choose whichever method best reflects how the asset actually loses value. Many small business owners simply follow the CCA rates for both to keep things simple.

Book depreciation vs. CCA (tax depreciation)

There are two reasons to calculate depreciation: for your own financial records (book depreciation) and for your tax return (Capital Cost Allowance). They serve different purposes and often produce different numbers.

Book depreciation is the method you choose for your internal financial statements. You pick the useful life, the salvage value, and the calculation method that best reflects how the asset actually loses value. The goal is accurate financial reporting.

CCA is the depreciation the CRA allows you to claim as a tax deduction. The CRA assigns every depreciable asset to a CCA class with a set rate. For example, most computer hardware falls under Class 50 at 55%, while general office equipment is Class 8 at 20%. You don't choose the rate; the CRA does.

This means the depreciation on your income statement may differ from the CCA deduction on your tax return. A piece of equipment you depreciate over five years using straight-line in your books might be claimed at a different rate under its CCA class. Both numbers are correct; they simply serve different audiences.

If you're unsure how to handle the difference, an accountant can help you set up both schedules so your books and your tax return stay accurate.

How to record depreciation

Recording depreciation involves a simple journal entry that moves a portion of an asset's cost into your expenses each period. Here is how it works.

Each time you record depreciation, you make two entries:

1. Debit your depreciation expense account (this increases your expenses for the period).
2. Credit your accumulated depreciation account (this reduces the book value of the asset on your balance sheet).

Accumulated depreciation is the running total of all depreciation recorded against an asset since you bought it. If you purchased a $10,000 machine and have recorded $6,000 in depreciation over three years, the accumulated depreciation is $6,000 and the asset's current book value is $4,000.

Most accounting software can handle these entries automatically once you set up the asset, the method, and the useful life. The numbers then flow straight through to your income statement and balance sheet without manual calculations.

How depreciation works for small businesses

Depreciation doesn't have to be complicated. It helps you understand your true costs, plan for asset replacements, and claim the tax deductions your business is entitled to.

With businesses of one to 19 employees making up 86.7% of all employer businesses in Canada, and 71.7% of those smallest firms facing cost-related obstacles in 2024, spreading the cost of equipment and software over its useful life helps owners match expenses to the periods when assets are actually generating income (Statistics Canada).

Most small businesses follow the CCA rates set by the CRA for their tax returns, and many use the same rates in their books to keep things straightforward. Once you set up your assets in your accounting software, the calculations happen automatically and the numbers flow into your financial reports.

If you have questions about which CCA class applies to your assets or how to handle the first-year rules, an accountant or bookkeeper can point you in the right direction.

Simplify your asset tracking with Xero

Tracking depreciation by hand takes time and leaves room for errors. Xero's cloud accounting software can help you manage your fixed asset register, calculate depreciation automatically, and keep your financial reports up to date without manual spreadsheets.

With everything in one place, you can see the current value of your assets, stay on top of CCA claims, and share accurate numbers with your accountant at tax time. Try Xero for your business and get one month free.

FAQs on depreciation

Here are some frequently asked questions about depreciation.

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 track the true cost of owning assets and can reduce your tax bill by spreading those costs over several years.

How is depreciation different from a regular business expense?

Regular expenses like office supplies are deducted fully in the year you buy them. Depreciation spreads the cost of larger, longer-lasting 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. In Canada, the CRA has specific rules for recaptured CCA and terminal losses that apply in these situations.

What is the difference between depreciation and amortization?

Depreciation applies to tangible, physical assets like equipment, vehicles, and buildings. Amortization applies to intangible assets like patents, copyrights, and software licences. Both spread the cost of an asset over its useful life, but they apply to different types of property.

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, showing its current book value.