How to estimate the useful life of a fixed asset
July 21, 2012
Should the useful life of a newly acquired fixed asset be the same as its physical life? This and other questions related to fixed asset useful lives are answered in this article.
To determine the depreciation expense on a fixed asset, companies must estimate the useful (service) life of the fixed asset as well as its salvage value.
To estimate the useful life, a company might use (i.e., non-exhaustive list):
- Its past experience with the same or similar assets
- Engineering estimates
- Industry practices
- Statistical methods
- Judgmental estimates
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
Useful life estimates are subject to managementís judgment and can be revised during the life of the fixed asset.† To learn more about the accounting for the change in the useful life estimates, refer to the article on How to Account for an Increase in the Useful Life of a Fixed Asset.
Because estimating the useful life of a fixed asset represents an uncertainty, a business should follow conservative accounting practices in doing so. To learn more about conservatism, refer to the article on What are the Exceptions to Basic Accounting Principles.
The understatement of the useful life when a fixed asset is purchased is one of the window dressing techniques used by companies to improve their performance appearance: during the life of the fixed asset, the company can prolong its useful life estimates, and as the result, it can decrease its depreciation expense and increase its net income. When analyzing the useful life estimate, in such a case, one can look at industry norms to see whether a company is overstating its earnings by using useful life estimates that are unjustifiably long. To learn more about window dressing, refer to the article on Window Dressing in Accounting.