Depreciation in Xero: why the equipment you bought is not a cost on your Profit and Loss

Short answer: equipment, vehicles and machinery that the business will use for years are fixed assets, not running costs. In Xero they are coded to a fixed asset account and sit on the Balance Sheet. Their cost reaches the Profit and Loss a slice at a time as depreciation, a cost line that spreads the price over the years you use the thing. So the month you buy a $36,000 machine, profit drops by one month’s depreciation (say $600), not by $36,000. Your bank balance is a different story: the money leaves on the day you pay, which is one of the most common reasons a business shows a profit but has no cash.

Two consequences catch owners out. If the purchase is coded to an expense account instead, that month’s profit is wrecked and the year looks worse than it is. And if nobody runs depreciation in Xero, every month’s profit is a little too high until the accountant posts it at year end. Menu names move between Xero releases; if a label below does not match your screen, search Xero Central for “fixed assets”.

Expensed or registered: what changes

	Coded to an expense account	Registered as a fixed asset and depreciated
Month you buy it	The whole price is a cost	One month’s depreciation
The rest of its life	Nothing	One month’s depreciation each month
Bank balance	Down by the full price on the day you pay	Down by the full price on the day you pay
Balance Sheet	Nothing	The asset at cost, less depreciation so far

A worked year: a landscaper’s mini excavator

An Australian landscaping business makes about $10,000 a month before depreciation (all figures excluding GST). On 1 July, the first day of its financial year, it buys a mini excavator for $36,000 and pays from the bank. It expects to use the machine for five years.

Coded straight to an expense account, the Profit and Loss reads:

Month	Excavator cost	Net profit
July	$36,000	-$26,000
August to June (each)	$0	$10,000
Year	$36,000	$84,000

July looks like a disaster, every other month looks better than it really is, and the year is $28,800 lower than it should be, because four-fifths of the machine’s useful life is still ahead.

Registered as a fixed asset, straight line over five years with nothing left at the end, depreciation is $36,000 / 5 = $7,200 a year, or $600 a month:

Month	Depreciation	Net profit	Excavator on the Balance Sheet at month end
July	$600	$9,400	$35,400
August	$600	$9,400	$34,800
September to May (each)	$600	$9,400	falls by $600 a month
June	$600	$9,400	$28,800
Year	$7,200	$112,800

Every month now shows the business’s real run rate of $9,400, including the cost of using the machine. The other $28,800 is still on the Balance Sheet and will reach the Profit and Loss over the next four years.

The bank balance is the same in both versions: down $36,000 in July. That is why the cash in the bank can sit tens of thousands below the year’s profit; the profit but no cash guide walks through the other usual causes.

How to set it up in Xero

1. Check you have the accounts. In Accounting > Chart of accounts you need a fixed asset account for the type of asset (for example Plant and Equipment, or Motor Vehicles), an Accumulated Depreciation account to go with it, and a Depreciation expense account. Xero’s default chart usually has them; add any that are missing.
2. Code the purchase to the fixed asset account. Enter the supplier bill (or reconcile the bank payment) with the full $36,000 coded to Plant and Equipment, not to an expense account. GST is claimed as normal.
3. Register the asset. Open the fixed assets register (Accounting > Advanced > Fixed assets). Purchases coded to a fixed asset account are listed there to register, or you can add the asset yourself with New asset. Enter the purchase date and price, then the depreciation settings: method (Straight line here; Xero also offers diminishing value and full depreciation at purchase), and the useful life or rate.
4. Run depreciation every month. In the register, click Run Depreciation and run it to the last day of the month. Xero posts the journal: Depreciation expense up $600, Accumulated Depreciation up $600, so the asset’s book value falls to $35,400.
5. Check it on the Balance Sheet. Plant and Equipment should show $36,000 at cost, with Accumulated Depreciation of $600 more each month. If the Balance Sheet still shows the full $36,000 with nothing taken off in March, depreciation has not been run since the purchase.

Many small businesses leave step 4 to the accountant once a year. That is fine for tax, but it means every monthly Profit and Loss until then leaves out the cost of the equipment. Running it monthly takes one click once the assets are registered, and it belongs on the month-end checklist. Left to the year end, it is often the biggest single adjustment: the Xero year end checklist has an example where £8,400 of unrun depreciation had overstated every month by £700.

Three things that catch owners out

• Cash basis reports leave depreciation out. If you read the Profit and Loss on cash basis, there is no depreciation line at all, so profit looks higher than the real cost of running the business. Owners and accountants have asked Xero for an option to show it on cash basis; for now it is accrual basis only. Cash vs accrual in Xero covers what else differs.
• Tax depreciation can be different. What you can claim for tax depends on your country’s rules (in Australia, for example, small businesses may be able to write off an eligible asset in full in the year they buy it, under a dollar limit that changes). That is your accountant’s call at year end and does not have to match the depreciation in your monthly reports.
• Small items are not worth registering. A $300 drill is usually just an expense. Many businesses set a dollar limit below which they do not register assets; ask your accountant what yours should be.

Common questions

Why is the van I bought not on my Profit and Loss? Because it was coded to a fixed asset account, so it sits on the Balance Sheet. Its cost reaches the Profit and Loss as depreciation, a share each month or year over its useful life.

What is depreciation on a Profit and Loss? A cost line that spreads the price of equipment, vehicles and machinery over the years the business uses them. No money leaves the bank when it is posted; the cash went out when you bought the asset.

How do I record depreciation in Xero? Register the asset in the fixed assets register with its price, date and depreciation method, then click Run Depreciation to the month end. Xero posts the journal to Depreciation expense and Accumulated Depreciation for you.

Why does depreciation not show on my cash basis Profit and Loss? Xero leaves depreciation out of cash basis reports. Switch the report to accrual basis to see it.

Does depreciation reduce my cash? No. Depreciation is a cost with no payment that month. The cash left when you paid for the asset, which is why cash flow calculations add depreciation back to profit.

Should I expense or capitalise equipment? Anything that will last more than a year and costs more than a small limit is usually capitalised (registered as a fixed asset) so one month’s profit is not wrecked. The dollar limit and the tax treatment are your accountant’s call.

Where does depreciation show on the Balance Sheet? Under fixed assets, as Accumulated Depreciation taken off the asset’s cost. Cost less accumulated depreciation is the book value; how to read a Balance Sheet in Xero covers the rest of that report.

See the cost of your equipment in every month

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