What Is Depreciation? Straight-Line vs Declining Balance, Useful Life, and Small-Asset Rules

When you buy a 300,000-yen computer or a one-million-yen machine for your business, you cannot always treat the entire amount as an expense for "the year you bought it." For high-value assets that you use for a long time, you need to turn the purchase price into an expense gradually over several years. This accounting procedure is called depreciation. This article explains, step by step, what depreciation is, how it is calculated, and how sole proprietors handle it on a tax return.

What Is Depreciation

Depreciation is the accounting procedure of taking the cost of acquiring a high-value asset used over a long period (a fixed asset) such as a building, machine, vehicle, or computer, and rather than expensing it all in the year of purchase, allocating it little by little as an expense over the period the asset can be used.

Why is it handled this way? Suppose you buy a one-million-yen machine and use it for five years to generate sales. The cost of that machine is not just for "the year you bought it"; it contributes to five years of business activity. So it represents each year's profit more realistically to apportion the cost over those five years and record a little expense each year. This is called the matching principle.

Assets lose value as time passes and through use. It helps to think of depreciation as a mechanism for recognizing that "loss of value" as an expense each year. Note that an asset whose value does not decline over time, such as land, is not subject to depreciation.

When you want to estimate how much an asset on hand can be depreciated, enter the acquisition cost and useful life into the Depreciation Calculator to instantly see a guide to the annual depreciation amount.

Acquisition Cost, Useful Life, and Residual Value

To understand depreciation, you first need to grasp three basic terms.

• Acquisition cost: the amount spent to obtain the asset. It includes not only the item price but also costs needed to bring the asset into usable condition, such as delivery freight, setup, and installation fees.
• Useful life: the period over which the asset is expected to be usable. Instead of the actual lifespan, you use the "statutory useful life" set by the government for each type of asset. For example, a computer is 4 years, a light vehicle is 4 years, and a wooden office is 24 years.
• Residual value: the value expected to remain after the useful life is used up. It was once set at 10% of the acquisition cost, but under the current system it is, in principle, calculated as zero (leaving just 1 yen on the books as a memorandum record).

It is important that you cannot freely decide the useful life yourself. Even if you think "it looks like it will break soon, so I want to depreciate it over 2 years," you must follow the statutory useful life. You can check how many years apply to each asset in the National Tax Agency's useful-life table.

Straight-Line vs Declining-Balance Method

There are mainly two ways to calculate depreciation: the straight-line method and the declining-balance method. Over the total useful life, the total amount depreciated is the same for both, but the pace of "how much to allocate each year" differs.

The straight-line method multiplies the acquisition cost by the same rate each year, depreciating the same amount throughout the useful life. For example, with an acquisition cost of 1.2 million yen and a useful life of 6 years, you expense 200,000 yen evenly each year. It is easy to understand, and because each year's burden is constant, it is easy to forecast.

The declining-balance method multiplies the remaining undepreciated balance by a fixed rate each year. The first year's depreciation is the largest and decreases year by year. Because you can expense more early on, it suits cases where you want to hold down profit right after a purchase.

For sole proprietors, the default is the straight-line method, and if you want to choose the declining-balance method you must file a notification with the tax office in advance (some assets such as buildings are limited to straight-line). The total is the same either way, but it affects the timing of each year's profit and tax, so it is important to choose a pace that fits your business. Comparing the year-by-year progression of each method in the Depreciation Calculator makes the difference intuitive.

The Special Rule for Small-Value Assets

Depreciating even small-value assets over many years is a hassle. So for assets below certain amounts, exceptional treatment is available that lets you expense them sooner.

• Under 100,000 yen: in principle, no depreciation is needed; you can expense the full amount in the year of purchase (as supplies, etc.).
• 100,000 to under 200,000 yen: as a "lump-sum depreciable asset," you can depreciate it evenly over 3 years regardless of the useful life.
• Under 300,000 yen: small and medium-sized businesses filing a blue tax return can, under the special rule for small-value depreciable assets, expense the full amount of an asset under 300,000 yen per item in the year of purchase (up to a total of 3 million yen per year).

The third one, the special rule for small-value depreciable assets, is especially handy for sole proprietors and freelancers. For example, if you buy a 250,000-yen computer, you would normally depreciate it over several years, but a blue-return filer can expense the full 250,000 yen that year. It helps reduce tax in profitable years, but it is a time-limited measure with conditions such as filing a blue return and the amount cap. Always check the latest requirements before using it.

How Sole Proprietors Handle It on a Tax Return

Sole proprietors record depreciation as a necessary expense on their tax return. In practice, you fill in the "depreciation calculation" section (a table within the blue-return financial statements or the statement of income and expenses) attached to the return, entering each asset's acquisition cost, acquisition date, useful life, depreciation method, and this year's depreciation.

A common mistake here is the monthly proration when you buy an asset partway through the year. For example, an asset purchased in October was not in use from January, so for that year you depreciate only the number of months used (three months, October to December), not a full year. Also, for an asset used both for business and privately (a home-cum-office building, or a car also used personally), only the portion corresponding to the business-use ratio (business ratio / apportionment) becomes an expense.

Depreciation is an expense you can record without an actual cash outlay, and it compresses income and affects your tax. When you want to estimate the overall picture of your income and tax, enter your sales and expenses into the Freelance Tax Calculator to check a rough guide to income tax and resident tax. It also makes it easier to picture your take-home pay once depreciation is included as an expense.

Note that depreciation rules vary in detail by asset type and acquisition timing. If you are unsure, grasp the overall picture with tools such as the Freelance Tax Calculator, and then confirm the specific contents of your return with a tax accountant or the tax office to be safe.

Summary and Cautions

Depreciation is a mechanism for allocating the cost of a high-value fixed asset used over a long period as an expense, little by little, over its useful life. The key points are as follows.

• High-value assets used over a long period cannot be expensed all at once in the year of purchase; they are allocated over the useful life.
• The calculation uses acquisition cost, statutory useful life, and residual value (in principle zero).
• Straight-line depreciates the same amount each year; declining-balance depreciates more in the early years. The default for sole proprietors is straight-line.
• There are special rules at the 100,000-, 200,000-, and 300,000-yen thresholds that let you expense assets sooner.

First, estimate the depreciation of an asset on hand with the Depreciation Calculator, and check the impact on your overall tax with the Freelance Tax Calculator. Actually moving the numbers is the shortcut to understanding the system.

Please note that this article is intended to provide general information and does not guarantee any individual tax judgment. Systems such as useful lives, special-rule requirements, and application deadlines may be revised. When filing your actual return, check the latest official information from the National Tax Agency, and consult a professional such as a tax accountant as needed.