Useful Life (Asset) - Explained
What is the Useful Life of an Asset?
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Table of ContentsWhat is Useful Life?How is Useful Life Used? Useful Life and Straight Line DepreciationUseful Life and Accelerated DepreciationUseful Life AdjustmentsAcademic Research for Useful Life
What is Useful Life?
Useful life is a term that can be applied to asset, whether long-term assets or short-term assets. The useful life of an asset refers to the period of time during which the asset was used for the intent it was purchased. This is the estimated lifespan of an asset, the number of years that an asset it estimated to remain in service for and generate profit. The useful life estimates of different assets vary depending on how long the asset has been used before purchase, the time of purchase and what the asset is being used for. The useful life of an asset is important to the IRS because it informs the depreciation of the fixed asset.
How is Useful Life Used?
Generally, short term assets have a useful life of less than a year, these assets include cash and cash equivalents, accounts receivable, marketable securities, prepaid expenses and inventory. Fixed asset on the other hand have longer periods as their useful life, assets like these are land, machines, facilities, buildings and equipment. The useful life of a fixed asset is important for accounting purpose because such asset depreciates, the longer their useful life is. One a fixed asset becomes depleted or is unable to generate income or serve the purpose for which it was bought, its useful life has ended. The useful life of fixed assets is measured in years.
Useful Life and Straight Line Depreciation
It is important to know that in most cases, the useful life of a fixed asset does not match the economic value or physical life of the asset. If the depreciation of a fixed asset is to be calculated using the straight line model, the formula that will be used is; The cost of an asset / the estimated life of the asset. The above calculation will help identify the annual depreciation value of the asset. For instance, if a machine was purchased for $750,000 and its estimated useful life is 15 years, using the above formula; The annual depreciation value of the asset = $750,000/ 15 = $50,000.
Useful Life and Accelerated Depreciation
When accelerated depreciation method is used to calculate depreciation in fixed assets, the book value of the asset decreases faster because higher depreciation levels are applied to the early years of the assets. Using the accelerated model, that the asset is exposed to greater deductions at its earlier years and the dollar amount of the depreciation reduces each year throughout the period the asset was in use.
Useful Life Adjustments
There are certain conditions that can cause adjustments to be made to the measurement of the useful life of an asset. For instance, if a machine becomes obsolete in no time due to the development of certain technologies that were not in the machine before, the useful life estimate of such assets will be adjusted. The adjustment is due to the advent of the new technology because without the introduction of the new technology, the machine might still have more useful years.