What Is Useful Life?
Useful life refers to the estimated length of time organizations can profitably use an asset before replacement. Notably, the term does not refer to the entire expected life span of an asset; most machines can and do last beyond their useful life. However, even when functional, old assets often cost more in maintenance expenses than new equipment costs due to increasingly frequent repairs.
It’s a known fact that fixed assets—pieces of equipment, machinery, and building components—depreciate over time. Useful life is a critical component of effectively managing assets to obtain their maximum value. Essentially, companies rely on the Useful life metric to determine the tipping point at which investments become more expensive to maintain than to buy new.
It’s key to maintenance planning as it informs decisions on whether to conduct repairs on aging investments or run them to failure. It’s often more cost-effective to replace an asset that’s nearing the end of its life rather than to repair it. This calculation is critical, considering aging equipment causes 40 percent of unplanned downtime.
But maintenance professionals aren’t the only ones concerned with the metric. Organizations also use the metric to calculate depreciation for tax and financial planning according to the Internal Revenue Service’s Topic No. 704.
How to Determine the Useful Life of an Asset
Even for the same type of asset, cost-effective holding may vary from one organization to the next. Many factors—equipment age, working environment, maintenance policies, asset usage, etc.—impact whether an organization should allow an asset should be replaced or not.
This makes it difficult to calculate the absolute value of an asset’s useful life. However, companies can use several methods to estimate the time frame, including:
- Consulting the IRS: This is the simplest way to determine the useful value of an asset. The agency’s Publication 946 lists the estimated useful life for various assets depending on industry and application. The estimates can serve as a baseline to determine the metric for similar assets.
- Checking Manufacturer Specifications: Manufacturers also provide data to help determine the metric. This information is often more precise than IRS estimates. However, manufacturer specifications aren’t always straightforward. They may list useful life in terms of the number of cycles or operating hours. Both figures can guide organizations toward making accurate calculations based on daily usage.
- Researching Past History: Organizations also can rely on data from similar assets to determine new assets’ Useful Lives. Some assets can last longer than manufacturer specifications when deployed for specific uses. This can help organizations to extend the value of similar assets.
- Making Annual Adjustments: Over time, assets wear out with prolonged use. But implementing a well-planned maintenance strategy can help prolong the useful life of the investment. Major asset failures also should be factored in when estimating the figure. Additionally, as businesses scale or change their operations, assets may require upgrades or be rendered obsolete.
Monitoring asset performance and management through a Computerized Maintenance Management System (CMMS) can help managers obtain accurate data to inform reliable estimates.
Example of Asset Useful Life
Say a manufacturing company purchases a new forklift. The industry standard for average forklifts is 10,000 hours. While practicing recommended preventive maintenance inspections will extend the machine’s useful life, the organization will reach a point where the inspections cease to be economical. While the forklift could remain operable for more than a decade, the cost of maintenance will eventually exceed the cost of replacement.
Once the machine has surpassed its estimated useful life, management should allow the machine to run to failure. With that said, several factors will impact its useful life, including the severity of its application, how much time operators use it per month, and the type/frequency of maintenance it receives.
How Useful Life Affects Depreciation
An asset’s useful life is integral to its depreciation. You can calculate depreciation by dividing the costs of an asset by its estimated useful life.
Here’s an example:
An asset valued at $38,000, with a useful life of 10 years, depreciates $3,800 per year. That is $38,000 ÷ 10 years = $3,800/yr.
However, say the same asset has a useful life of 15 years, its depreciation will be $2,533 per year. That is $38,000 ÷ 15 years.
When an asset has a lower depreciation value with a longer useful life, the company can take deductions for a more extended period and save more in the long run.
Organizations rely on useful life to predict how long an asset is profitable to their business. Besides impacting asset purchases and maintenance decisions, organizations can use the metric to calculate asset depreciation for tax purposes.