Selecting useful lives to depreciate fixed assets over can be a difficult task. It is hard to predict how long an asset will last or how long it will be before it becomes obsolete. The answer to this question first depends on the type of asset. A computer, for example, can become obsolete well before it actually wears out and doesn’t work anymore, because of things like new software and technological advancements. A vehicle or piece of machinery, on the other hand, can be used for business purposes until it does not operate normally anymore due to normal wear and tear, a lot of times without first becoming obsolete. Likewise, a building can be used for business virtually indefinitely, as long as it is maintained, without ever becoming obsolete. Therefore, it does not make sense to use the same useful life over different asset categories. Consideration needs to be made for both how long the asset will operate normally, with routine upkeep and maintenance, before normal wear and tear cause it to stop working, and how long the asset will be of use to the business before a better asset is developed and the business can gain efficiency with the newer asset. Another factor to consider is whether the asset is new or has been used before, as new assets will tend to have longer useful lives.
Generally accepted accounting principles does not provide a lot of specific guidance on how long useful lives of assets should be, except in the case of leasehold improvements, which should be amortized over their estimated useful lives or the term of the lease, whichever is shorter. Many companies will have a certain useful life that they use for certain types of assets, and will apply those lives to new assets that are of that type and are added in the future. Some companies will also simply follow the IRS standards for useful lives and apply those lives to new assets, which are generally a good starting point for smaller companies. This will result in assets depreciating over the same useful life for book and tax; however, the depreciation methods likely will be different. A word of caution in using the same useful lives assigned for tax purposes is that a company needs to ensure that these lives assigned to the assets fall within a reasonable range of the asset’s useful life. A simple way to test if your current useful lives of assets are appropriate is to look at assets that have been fully depreciated, but are still in use. The assets that meet these criteria have been given too short of a useful life, and an adjustment may be necessary for the useful lives of assets purchased in the future if experience is showing that they are lasting significantly longer than the current assigned useful life.
In summary, assigning useful lives to fixed assets takes some judgment on the part of management. Useful lives may vary by each asset, each category of asset, and from company to company. Management’s plans, how the assets will be utilized, and the amount of time before they become obsolete all play a factor in estimating the useful life of an asset.
By Tyler Henkel