How long is an asset's lifespan?
With arguably few exceptions, most tangible assets used in business have a finite life span—usually a period of several years or more with a predictable beginning and end.
The life span, or lifecycle concept is central to asset lifecycle management (methods for guiding asset acquisition, use and disposal). The concept is the heart of total cost of ownership (TCO) analysis (methods for uncovering the full range of costs brought by asset ownership).
The asset lifespan, or lifecycle concept is also of keen interests to the company's accountants, who attempt to maximize the benefits of depreciation expense, and to the company's financial officer's, responsible for maximizing the company's return on assets.
Asset life span can in fact defined and measured in several different ways, including depreciable life, economic life, service life, and ownership life. These different lives are further defined below.
- How long is an sset's lifespan?
- What is asset depreciable life?
- What is asset economic life?
- What is asset service life?
- What is asset ownership life?
What is asset depreciable life?
Depreciable llfe is defined as the time period over which an asset can lawfully be depreciated. Each year of depreciable life, a depreciation expense is calculated and declared for the asset using standard accounting methods. This expense lowers the book value (balance sheet value) of the asset, lowers the company's reported income, and creates a tax savings.
When the its depreciable life is over, the asset is said to be fully depreciated or fully expensed. If the asset is kept beyond that point, its book value is called either its residual value or its salvage value. Asset residual (or salvage value) is typically just a few percent of the asset's original purchase price or it may even be 0. (See the encyclopedia entry on depreciation.)
For some assets, management can simply choose a number of years for the depreciable life, based on the asset's expected useful life. For other kinds of assets, however, the depreciable life is prescribed by the country's tax authorities. In the US, for instance, computing hardware has a prescribed depreciable life of 5 years, and depreciation must follow the MACRS (Modified Accelerated Cost Recovery System) depreciation schedule.
What is asset economic life?
The asset's economic life is defined as the number of years in which the asset returns more value to the
owner than it costs to own, operate, and maintain. When these costs
exceed returns, the acquisition is beyond its economic life.
The asset's economic life must be known in order to calculate investment metrics such as net present value, internal rate of return, and return on investment. An asset's expected economic life is also an important consideration for vendors and customers alike when establishing warranties and service plans.
An asset's economic life can be shortened or terminated by a number of different factors, including:
- Wear, degradation, or damage which can lower asset performance and raise maintenance and operation costs.
- Obsolescence, which can raise maintenance costs and render asset performance relatively inefficient when compared to more current alternatives.
- Changes in company operations, product offerings, or the company's business model, which reduce the value certain assets can deliver.
What is asset service life?
An asset's service life is defined as the number of years the acquisition will actually be in service. An asset's service life is considered over when all of the following conditions exit:
- The asset is sitting idle, not in use for any purpose.
- The asset is not being retained as a contingency "back up," that could be put into service when other assets fail
- The asset is not being retiained for use as a source of "spare parts" for other assets in service.
The asset's service life is over, in other words, when it is providing no business value of any kind to owners.
What is asset ownership life?
All of the above "lives" may be different, and all may contribute to the owner's judgement as to what the ownership life should be. In business analysis, an asset's ownership life is the complete length of time that a decision to own the asset has financial consequences.
- Ownership life begins when the decision to acquire the asset begins causing costs. This may include costs that occur before the actual arrival or asset use begins, such as loan origination fees, planning costs, transportation costs, or set up costs.
- Ownership life ends when the asset stops causing costs and in fact has no continuing financial impact of any kind. This means, for example, that all costs of disposal or decommission have been paid and it is no longer carried in an asset account on the company's balance sheet.