Useful life

What it means

Useful life is the period over which a business expects to use an asset productively. The accounting depreciation plan is based on it: if a company expects to use a machine for eight years, it spreads the cost over eight years.

It can differ from physical life. A computer may work for ten years, but the business uses it economically for three or four before it becomes obsolete. Estimates take into account wear, technical progress, planned intensity of use and contractual or legal limits.

Accounting useful life may differ from the tax depreciation period set by the depreciation group. The difference between accounting and tax depreciation creates a temporary difference, from which companies that account for deferred tax calculate a deferred tax liability or asset.

How it works in practice

The company sets useful lives in an internal policy for asset groups, for example cars five years, computers three years, buildings thirty to fifty years. For significant assets, the estimate should be supported by technical data or experience with similar assets.

If an asset consists of parts with different lives, such as a building with a roof and a lift, the company may use component depreciation. Each part is then depreciated over its own life, which better reflects actual wear.

Useful life estimates should be reviewed regularly. If a machine turns out to last longer or shorter, the depreciation plan is adjusted prospectively, meaning the net book value is spread over the new remaining life without restating past years.

What to watch out for

For simplicity, companies sometimes equate accounting useful life with the tax depreciation period. This is practical but may not give a true picture. If an asset is used much longer or shorter, the auditor may require an adjustment.

Too short a useful life raises costs in the early years and lowers reported profit, while too long a life defers them. Both errors distort the results and measures such as EBIT that banks and investors watch.