With arguably few exceptions, most tangible assets in business have a finite lifespan. Asset lifespan is usually several years or more with a predictable beginning and end.
The lifespan or lifecycle concept is central to asset lifecycle management (methods for guiding asset acquisition, use and disposal). And, the idea is the heart of "Total cost of ownership" (TCO ) analysis (methods for uncovering the full range of costs that follow from asset ownership).
The owner's accountants also take a keen interest in asset lifespan, because they will attempt to maximize the benefits of depreciation expense across it. And, financial officers also take a keen interest in asset lifespan because they are responsible for maximizing the firm's return on assets.
Businesspeople define and measure asset lifespan in several different ways, including:
- Depreciable Life
- Economic Life
- Service Life
- Ownership Life
Sections below define and explain each of these lives.
- How long is an asset's lifespan?
- Firstly, what is an asset's "depreciable Life?"
- Secondly, what is an asset's "economic life?"
- Thirdly, what is an asset's "service life?"
- Fourthly, what is an asset's "ownership life?"
The time over which an asset can lawfully depreciate to its salvage value defines its depreciable life. Each year of this life, owners calculate a depreciation expense for the asset using standard accounting methods. This expense reduces the book value (Balance sheet value) of the asset, reduces the company's reported income, and creates tax savings.
When this life is over, the asset is said to be entirely "depreciated" or "fully expensed." The latter term recognizes that most or all of asset book value transforms into expense as it depreciates.
If owners keep the asset beyond that point, its book value is called either residual value or salvage value. Asset residual (or salvage) value is typically just a few percents of an asset's original purchase price. Residual value may in fact even be 0. For more on depreciation terms, see Depreciation.
Choosing Depreciable Life
For some assets, owners designate an arbitrary number of years for the depreciable life, usually referring to the asset's expected useful life. For other kinds of assets, however, this life is prescribed by the country's tax authorities. In the US, for instance, computing hardware has a stated depreciable life of 5 years. And, its depreciation must follow the MACRS (Modified Accelerated Cost Recovery System) depreciation schedule.
The number of years in which the asset returns more value to the owner than it costs to own, operate, and maintain, defines its economic life. When these costs exceed returns, the asset is beyond its "economic life."
Owners must estimate an asset's economic life to calculate investment metrics such as "Net present value," the "Internal rate of return," and "Return on investment." An asset's expected economic life is also an essential consideration for vendors and customers alike when establishing warranties and service plans.
Several different factors can reduce or end an asset's economic life, including:
- Wear, degradation, or damage
These factors lower asset performance and raise maintenance and operation costs.
Obsolescence 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
These factors can reduce the value certain assets can deliver.
The number of years the acquisition will be in service defines its service life. An asset's service life is over when all of the following conditions exist:
- The asset is sitting idle, and it is not in use for any purpose.
- Owners are not retaining it as a contingency "back up," that could go into service when other assets fail
- Owners are not retaining it 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.
All of the above lives may be different, and all may contribute to the owner's judgment as to what the "ownership life"should be. As a result, in business analysis, an asset's "ownership life" is the complete length of time that ownership has financial consequences.
- Ownership life begins when the decision to acquire the asset starts causing costs. Some of these costs may appear 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. "No continuing financial impact" means, for example, that all costs of disposal or decommission are over, and asset value no longer contributes to an asset account on the company's Balance sheet.