What is an Asset’s Useful Life?
When businesses acquire an asset, they don’t expect it to last forever. In fact, they only expect it to last for a certain length of time before it no longer provides value. This is the asset’s useful life: the period of time it’s estimated usable for its acquired purpose.
Asset useful life is an important consideration for accounting because it factors into depreciation modeling. Businesses depreciate assets from the balance sheet at either an accelerated or linear rate—and in either case, the company needs to understand the time horizon for that write-down. It’s a process that demands insightful decision-making and informed hypothesis.
Here’s a closer look at asset useful life, what it really means and how this measurement factors into financial accounting.
Which Assets Have a Useful Life?
Not every asset a business acquires has a useful life—at least, for the purpose of depreciation. Useful life only applies to tangible assets that stay on the balance sheet for more than one year (fixed or current). These are assets that carry over across accounting periods, which gives the business the ability to depreciate them over a certain period of deemed usefulness. Examples of depreciable capital assets include:
- Heavy equipment
- Other physical assets
Depending on the nature of business, some companies naturally carry more depreciable assets than others. A Software-as-a-Service company may list a few depreciable electronics and office furnishings on its balance sheet, while a mining company may have millions of dollars in depreciable assets between equipment, trucks, machinery and more.
Every company needs to keep useful asset life in mind as they consider how the depreciation of assets affects financial reporting.
How to Determine an Asset’s Useful Life
Every asset will have a different useful life. This means it’ll also have a unique depreciation schedule. It depends on how long the company believes the asset will remain useful. For example, a vehicle might only have a useful life of five years, while a piece of industrial equipment may benefit the company for more than a decade.
Determining asset useful life is a tricky process that requires some informed guesswork. Some of the key factors to consider include the age of the asset when purchased, frequency of use and the conditions of its application. This, combined with the IRS schedule guidelines for asset depreciation, help companies make informed decisions about useful life. Generally, however, assets will fall within a useable life of either three, five, seven, 10, 15, 20, 28 or 39 years. Examples include:
- Three years: Horses and tractors.
- Five years: Cars, fax machines and research equipment.
- Seven years: Office furniture and fixtures.
- 10 years: Horticulture assets, including fruit-bearing trees.
- 15 years: Property and land improvements, such as fences.
- 20 years: Non-agricultural farm buildings or structures.
- 28 years: Residential rental properties.
- 39 years: Non-residential real estate (less the value of land).
The asset’s useful life marks the length of its depreciation schedule, which dictates the depreciable amount each year it’s held. Depreciation method—accelerated or straight-line—also factors in when determining the percentage of total asset value depreciated for each remaining year of its useful life.
Accelerated vs. Straight-Line Depreciation
The useful life of an asset plays a big role in how a company chooses to depreciate that asset. There are two options: accelerated depreciation and straight-line depreciation.
- Accelerated depreciation involves depreciating more of an assets value earlier on in its useful life, taping the total amount of depreciation in later years. For example, a company might depreciate a vehicle 38% in the first year, 25% in the second year, 17% in year three, 13% in year four and 7% in the fifth and final year.
- Straight-line depreciation involves writing down the same amount across every year of the asset’s useful life. For example, if a car has a five-year useful life, the company would depreciate 20% of its value every year for five years.
Useful life plays a big role in accelerated vs. straight-line depreciation because it dictates how long the company will carry the asset on its balance sheet. Many companies accelerate assets to reduce their burden on the balance sheet—especially if they’ll only carry the asset for a few years. Straight-line depreciation is useful for assets with ongoing maintenance needs over time, as a way to offset those costs.
What is a Useful Life Adjustment?
Circumstances change over time, including when it comes to asset lifespans. A new technology can make an asset obsolete overnight. This shaves years off its useful life or wipes away its salvage value in a second. In these cases and similar situations, companies can file a useful life adjustment with the IRS.
A useful life adjustment changes the annual depreciable amount of an asset based on a new lifespan. Companies need to be aware of the financial implications that come with a useful life adjustment—especially for assets that are near the end of their original write-down schedule.
What Comes After a Useful Life?
When an asset is fully depreciated, that means the company can no longer derive value from it, outside of salvage value—the price it’s sold for. But assets don’t magically stop working once they’re depreciated. It begs the question: what happens at the end of an asset’s useful life?
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If the company keeps the asset around, its salvage value will remain on the balance sheet until it’s disposed of. The company can continue to use that asset, and many companies do. The key thing to remember is that it cannot record any further depreciation. That means no offset for any cost of ownership. It’s important for companies to take a good look at fully depreciated assets to understand how useful they still are, and whether the cost of ownership is worth carrying them on the balance sheet.