Depreciation explained: methods, examples and tax tips

Published Monday 26 October 2026

Table of contents

• What is depreciation?
• Purpose of depreciation: 3 main functions
• What can be depreciated?
• Common depreciation examples for small businesses
• Methods of calculating depreciation
• Choosing a depreciation schedule
• Capital allowances vs depreciation in Malaysia
• How to record depreciation in your books
• Depreciation for small business
• Track asset depreciation with Xero
• FAQs on depreciation

Key takeaways

• Record depreciation as a business expense on your profit and loss statement to accurately calculate your true costs and avoid overestimating profits.
• In Malaysia, claim capital allowances to lower your tax bill, as accounting depreciation is added back when you work out taxable income.
• Apply straight line depreciation for most small business assets by dividing the purchase price by the asset's useful life to get consistent annual depreciation amounts.
• Start depreciating an asset when it's ready for use in your business, not when you purchase it, and use accounting software to automate calculations and record keeping.

What is depreciation?

Depreciation is the gradual loss of value in a business asset over time. A work computer, for example, depreciates from its original purchase price down to RM0 over its productive life.

Accounting for depreciation means measuring this declining value and recording it in your books. A professional can help you navigate the details.

Purpose of depreciation: 3 main functions

Depreciation accounting has three key purposes for your business:

• Understanding true costs: Wear and tear is an expense that affects your bottom line.
• Reducing your tax bill: You may be able to claim asset value as a deduction.
• Estimating business value: Asset depreciation affects what your business is worth.

1. Depreciation as an expense (cost of doing business)

To understand how profitable your business is, you need to know all your costs. Depreciation is one of those costs because assets that wear down eventually need to be replaced.

Depreciation accounting helps you figure out how much value your assets lost during the year. That number needs to be listed on your profit and loss statement and subtracted 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.

2. Depreciation and tax

Depreciation can reduce your tax bill. You may be able to claim the entire value of an asset as a tax deduction over time.

In Malaysia, accounting depreciation is added back when you calculate taxable income. Instead, you claim capital allowances (initial and annual allowances under Schedule 3 of the Income Tax Act 1967), with small-value assets claimable in full subject to Inland Revenue Board of Malaysia (LHDN) limits.

However, there are rules around how quickly you can claim the cost of certain assets for tax purposes. Check with LHDN or your accountant for guidance specific to your situation.

3. 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 one with new trucks, for example.

Your assets are listed on your balance sheet in what's called the fixed asset register. Update the register whenever you calculate depreciation.

Assets are often used to secure loans. As they drop in value, they offer less security, and you may find it harder to get finance.

What can be depreciated?

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

Consumables like stationery can be deducted from tax, but you have to claim them in the year you bought them. Depreciation spreads the cost of fixed assets over multiple years.

What are fixed assets?

A fixed asset helps you generate income over more than a year. Common examples include:

• tools and machinery
• computers and office furniture
• vehicles
• buildings

You don't always have to own them. Some leased items may be depreciable too.

Intangible assets like patents and copyrights can also be depreciated (or amortised), a practice governed by accounting standards such as IAS 38 Intangible Assets.

Some assets can't be depreciated:

• Land: Land has an unlimited useful life and doesn't depreciate, with some exceptions like quarries or landfill sites.
• Inventory: You handle this separately under inventory accounting.

Common depreciation examples for small businesses

Here's how depreciation works in practice for typical small business assets:

• Work computer: You buy a laptop for RM1,500 with a three-year useful life. Using straight line depreciation, it loses RM500 in value each year until it reaches RM0.
• Delivery vehicle: You purchase a van for RM30,000 with a five-year useful life. Using straight line depreciation, it depreciates by RM6,000 per year.
• Office furniture: You buy desks and chairs for RM5,000 with a 10-year useful life. They depreciate by RM500 per year.
• Manufacturing equipment: You purchase machinery for RM20,000 that can produce 100,000 units. Using units of production depreciation, it loses RM0.20 in value for each unit produced.

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 at the same rate every year?

There are many methods for calculating depreciation, and some are quite complex. Here are three of the most common:

Straight line depreciation

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

Formula: Purchase price ÷ useful life = annual depreciation. For example, an asset expected to last five years would depreciate by one-fifth of its price each year.

Diminishing value depreciation

Diminishing value depreciation (also called reducing balance) applies a higher percentage of depreciation in the early years. The rate gradually slows down over time.

This method suits assets that lose value quickly at first, such as vehicles or technology equipment.

Units of production depreciation

Units of production depreciation bases how an asset's value declines on usage rather than time. Accounting standards specify that methods based on revenue are inappropriate because revenue reflects factors beyond an asset's actual wear and tear.

For example, a vehicle might depreciate based on kilometres travelled, or a packaging machine based on products boxed. This method suits assets where wear depends on output rather than age.

Choosing a depreciation schedule

A depreciation schedule determines how long you'll depreciate an asset. To set one up, you must first estimate the asset's lifespan, which accounting standards consider a matter of judgement based on the business's experience with similar assets. A computer might only last three years, while a factory kiln could last 30.

In Malaysia, LHDN sets the rates you use for tax, and these work separately from your book depreciation schedule. The next section explains how.

You can adjust an asset's value to zero at any time if it's lost, stolen or damaged. Assets can also be sold, traded or combined into a new asset.

Capital allowances vs depreciation in Malaysia

In Malaysia, capital allowances replace accounting depreciation when you work out your tax. You record depreciation in your books, then add it back and claim capital allowances at rates set under Schedule 3 of the Income Tax Act 1967.

That means each asset has two sets of numbers. Book depreciation goes in your financial reports, and capital allowances go in your tax return.

How initial and annual allowances work

Most capital allowance claims combine two parts. Here's how each one works:

• Initial allowance: You claim this once, in the year you incur the cost and start using the asset in your business. It's usually 20%.
• Annual allowance: You claim this each year on the asset's cost at its prescribed rate. It applies while the asset is in use at the end of your basis year.

Capital allowance rates for common assets

Rates depend on the type of asset. PwC Worldwide Tax Summaries lists these initial and annual allowance rates for common business assets:

• General plant and machinery: 20% initial, 14% annual
• Heavy machinery: 20% initial, 20% annual
• Motor vehicles: 20% initial, 20% annual, with limits on the maximum qualifying cost
• Office equipment, furniture and fixtures: 20% initial, 10% annual
• Information and communications technology equipment and computer software: 40% initial, 20% annual
• Industrial buildings: 10% initial, 3% annual

Before you claim for a car or van, check the current qualifying cost limits with LHDN or your tax agent.

Small-value assets and unused allowances

Lower-cost items get simpler treatment. The same PwC summary notes that small-value assets costing less than RM2,000 each qualify for a 100% allowance, up to a total cost of RM20,000. Different limits may apply to qualifying small and medium enterprises (SMEs), so check with LHDN or your tax agent.

Some years, your capital allowances may be more than your business income. You can carry the unused amount forward indefinitely and use it against future income from the same business source.

Worked example: office equipment

Say you buy office equipment for RM10,000 and expect it to last five years. Here's how the two approaches compare:

• Book depreciation: Straight line depreciation gives you RM2,000 a year for five years.
• Capital allowances: In the first year, you claim a 20% initial allowance (RM2,000) plus a 10% annual allowance (RM1,000), for RM3,000 in total. You then claim RM1,000 a year until the full cost is claimed in year eight.

Your tax claim is higher than your book expense in the first year and lower in years two through five. Once the book value reaches zero, capital allowances keep going for three more years.

How to record depreciation in your books

Recording depreciation involves updating your financial records to reflect the declining value of your assets. Here's how it works:

1. Create a journal entry: Each period, post a depreciation journal entry to record the expense and reduce the asset's book value. This affects both your profit and loss statement and your balance sheet.
2. Update your fixed asset register: Track each asset's original cost, accumulated depreciation and current book value. Review this register regularly to keep your records accurate.
3. Choose your timing: Most businesses record depreciation monthly or annually. Monthly recording gives you more accurate financial reports throughout the year.
4. Use accounting software: Xero calculates depreciation automatically based on your chosen method and schedule. The numbers flow directly to your reports, saving you time and reducing errors.

Depreciation for small business

Depreciation can be straightforward. It helps you understand your costs and may lower your tax bill.

Most businesses set a schedule based on how long similar assets usually last, then claim capital allowances separately for tax. Once it's set up in your accounting software, the maths happens automatically and the numbers flow straight through to your reports.

An accountant or bookkeeper can provide advice along the way if you need it.

Track asset depreciation with Xero

Depreciation shows the true cost of running your business, and capital allowances help lower your tax bill in Malaysia. With Xero, depreciation on your fixed assets is calculated automatically whenever you run it and your reports stay up to date, so you spend less time on the maths.

Find the plan that suits your business and get one month free.

FAQs on depreciation

Here are answers to common questions about depreciation for small businesses.

When should you start depreciating an asset?

Start depreciating an asset when it's ready for use in your business, not when you purchase it. If you buy equipment in March but don't install it until June, depreciation begins in June.

Can you change depreciation methods after you've started?

Yes, but follow accounting standards and adjust your records if needed. Check with your accountant before making changes, as this can affect your financial statements and tax returns.

What happens if you sell a depreciated asset before its useful life ends?

You'll need to calculate the gain or loss when you dispose of it. If you sell for more than the asset's book value, you have a gain. If you sell for less, you have a loss. Both affect your tax return.

Do you need to depreciate assets that cost less than a certain amount?

For tax in Malaysia, you can claim the full cost of each small-value asset costing less than RM2,000, according to PwC's Malaysia tax summary. This is subject to a total cap of RM20,000, though different limits may apply to qualifying SMEs.

How does Xero handle depreciation calculations automatically?

Xero lets you set up fixed assets with your chosen depreciation method and schedule. It calculates depreciation automatically whenever you run it and updates your reports, so you don't have to do the maths manually.