Rusty old car

Depreciation – what is it all about?

Man in traditional malaysian clothes crying as he looks over a broken down rusty car

Clients like to ask me this question:

‘So if I buy a car for the business, I can claim the entire $40,000 that I spent on it as an expense right?’


I’m sorry my dear client, but you will have to depreciate the amount over the fixed asset’s useful life as it is a capital expense and not an operating expense.

Depreciate? Useful life? Asset?? Capital/Operating expense???

Ok, there’s a lot of accountingese thrown in there, but in this article we’ll look at the difference between an ‘operating expense’ and a ‘capital expense’. Then we’ll use that as a spring board to talk more about depreciation.

Operating vs Capital Expense

As business owners we all know what expenses are right? In fact, we’ve written quite a bit about capital and operating expenses in the past. So I’ll keep this brief:

Operating expenses

Expenses related to running the business day to day. Examples are:

  1. Rent
  2. Wages
  3. Power bills
  4. Purchases of goods

And so on. These are expenses that you often spend on a regular basis, multiple times throughout the year.

Capital expenses

Capital expenses relate to the acquisition of fixed assets. Examples are:

  1. Buying a car
  2. Buying machinery
  3. Buying furniture

Capital expenses are often infrequent. You may make a capital expense once in every couple of years or so.

The big difference!

The biggest difference between capital and operating expenses is how they are treated for tax dedutibility. Operating expenses are fully claimable in the year they are incurred.

E.g. you pay $12,000 a year on rent – you can fully claim that rent as a tax expense within the financial year.

Capital expenses can’t be fully claimed in the year they are incurred. Instead, they are depreciated over their useful life. Which is a great segue into our next heading!


Depreciation (or capital allowances as it is known in some parts of the world) is the accounting process of determining what proportion of value of the fixed asset is used during the financial year. Confusing? Let’s illustrate:

Big Time Constructions Ltd buys a digger worth $100,000. This digger will last them the next 5 years for all their various construction projects. They can’t expense all $100,000 in the year of purchase because that would imply they’re only using the digger for the first year of business and are trashing it after the first financial year.

Instead, Big Time Constructions needs to ‘Depreciate’ the digger over its useful like (in this case – 5 years). This lets Big Time accurately (more or less) capture the value of the fixed asset as it is used in the business. Broadly speaking, there are two ways of doing this:

Straight line depreciation

If the business will be using the asset equally in every year of its useful life, you would simply take the cost value of the assets ($100,000) divide it by the useful like (5 years) and claim that amount for depreciation, every year for the next 5 years. This works out to $20,000 depreciation expense each year for the digger.

Note that if the digger has a residual value (a value at which it can be sold for at the end of 5 years) this residual value is deducted from the cost value of the asset before dividing it by the useful life.

Diminishing value depreciation

The more commonly used method in Aotearoa. Diminishing value assumes that the usage of the asset will is more in the earlier years and less in later years. Let’s say that 10% of the digger’s value will be used each year. In the first year, we depreciate $10,000 (10% of $100,000). Then, in the second year, we depreciate 10% of the remaining value (10% of $90,000) which is $9,000. In the third year we depreciate a further 10% of $81,000 which is $8,100.

This continues every subsequent year until the value of the asset is close to nil.

Depreciation is tax deductible!

Depreciation is how you claim tax deductions on your fixed asset purchases. By allocating a value of usage for the asset in the financial year, you reduce your tax liability. This is also part of the reason why new business owners buy a brand new ‘company’ car soon after starting a company. The other reason being that they like flash new cars.

Some tax jurisdictions have a cut-off point for fixed assets. In Aotearoa, this cut off point (as of financial year 2023) is $1,000. If you buy an asset worth $1,000 or less, you don’t have to depreciate it. You can claim the entire amount in the same financial year. This means that if you buy a laptop for $999.99 you can expense the entire amount in the year you bought it. If the laptop costs $1,001.00 you’ll have to capitalise it as a fixed asset and depreciate it over 2 to 3 years.

GST and depreciation

If you are GST registered, please ensure that the value that you use to calculate depreciation on fixed assets is GST EXCLUSIVE. DO NOT include GST when calculating depreciation. If you spent $11,500 on a fixed asset, GST inclusive, you need to remove the $1,500 GST and depreciate based on the $10,000. You can claim back the GST in your GST return.

If you are not GST registered, then you can depreciate based on the whole amount. Meaning that you include GST in determining the cost value of your asset.

Happy depreciating!

Fixed asset purchases don’t reduce your amount of profit. However, depreciation can reduce your profit. Different types of assets have different rates of depreciation. Check with your accountant on what sort of rates to use for your assets.

Stay positive!

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