What Does Useful Life Mean?
The useful life of an asset is an accounting estimate of the number of years it is likely to remain in service for the purpose of cost-effective revenue generation. The Internal Revenue Service (IRS) employs useful life estimates to determine the amount of time during which an asset can be depreciated. There are a variety of factors that can affect useful life estimates, including usage patterns, the age of the asset at the time of purchase and technological advances.
Understanding Useful Life
Useful life refers to estimated durations of utility placed on a variety of business assets, including buildings, machinery, equipment, vehicles, electronics and furniture. Useful life estimations terminate at the point when assets are expected to become obsolete, require major repairs, or cease to deliver economical results. The estimation of the useful life of each asset, which is measured in years, can serve as a reference for depreciation schedules used to write off expenses related to the purchase of capital goods.
Useful Life and Straight Line Depreciation
The depreciation of assets using the straight line model divides the cost of an asset by the number of years in its estimated life calculation to determine a yearly depreciation value. The value is depreciated in equal amounts over the course of the estimated useful life. For example, the depreciation of an asset purchased for $1 million with an estimated useful life of 10 years is $100,000 per year.
Useful Life and Accelerated Depreciation
Businesses may also elect to take higher depreciation levels at the beginning of the useful life period, with declining depreciation values over the duration of the time span using an accelerated model. The yearly write-offs in the reducing balance depreciation model decline by a set percentage rate to zero. Using the sum of the years method, depreciation declines by a set dollar amount each year throughout the useful life period.
Useful Life Adjustments
The duration of utility in a useful life estimate can be changed under a variety of conditions, including early obsolescence of an asset due to technological advances in similar applications. To change a useful life estimate in this circumstance, the company must provide a clear explanation to the IRS, backed by documentation comparing the old and new technologies. For example, if a company's original useful life estimate is 10 years, but new technology is likely to render it obsolete after eight years, the company may be able to accelerate depreciation based on a shorter schedule. In this situation, a company that is depreciating assets based on a 10-year schedule may be able to increase yearly depreciation values based on a newly abbreviated eight-year useful life estimate.