How to account for an increase in the useful life of a fixed asset

July 10, 2012

How should you account for a revision in the useful life of fixed assets? What financial statement impact does such revision have? Find answers to these questions in this article.

1. Accounting for the increase in the useful life of a fixed asset

When an entity purchases fixed assets (e.g., buildings, machinery, equipment), the management has to estimate the useful life and salvage value of the fixed assets in order to calculate the depreciation expense.

Accurately estimating the useful life and salvage value very far into the future is rather difficult. In addition, US GAAP does not provide a clear guide for determining the useful life or salvage value of long-lived assets.

As the result, companies usually determine deprecation rates based on their prior experience:

  • Useful life estimate: to determine the useful life of a fixed asset, a company may use historical information about similar assets, engineering information, expectations about obsolescence of fixed assets based on technological advancements, and so on.
  • Salvage value estimate: companies often assume salvage value to be zero.

During the life of an asset, the management might need to revise its accounting estimates of the useful life or salvage value of fixed assets.

Factors that may increase or decrease the useful life of fixed assets are presented in the table below.

Increase Useful Life

Decrease Useful Life

  • Extensive capital investments in fixed assets
  • Upgrading and regularly maintaining fixed assets
  • Improved maintenance procedures
  • Technological advances
  • Typical industry practices
  • Engineering department estimates
  • Revision of operating procedures
  • Unexpected physical deterioration
  • Unforeseen physical obsolescence
  • Technical obsolescence

Typical ranges of useful life estimates are as follows:

  • Automotive equipment: 3-6 years
  • Furniture and fixtures: 5-12 years
  • Machinery and equipment: 3-20 years
  • Buildings and improvements: 10-50 years

As we can see from the list above, many ranges are large: that is, the amount of uncertainly is high.

Useful life estimates are often subjective (i.e., in accordance with managementís discretion): the same fixed assets can be depreciated at a different rate by different companies. Broad ranges, as the result, might make the comparison across companies more difficult.

Finally, management might be less optimistic in estimating the useful life when fixed assets are purchased. This would allow the management to increase the useful life of fixed assets later on. The increase in the useful life would result in the decrease in the depreciation expense, and as the result, in the increase in net income. This is one of the examples of window dressing techniques used to improve the appearance of an entityís performance or liquidity. To learn more about window dressing, refer to the article on Window Dressing in Accounting.

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