Businesspeople in general refer to many different kinds of asset lives. Owners, managers, and analysts, however, focus on four asset life cycles, or lifespans, in particular: Economic Life, Depreciable Life, Service Life, and Ownership Life.
1. Asset Economic Life
An asset's economic life is the time period during which the asset returns more value to owners than it costs to own, operate, and maintain. When these costs exceed the value of the returns, the asset is beyond its economic life. Economic life is given as a number of years.
Economic Lifespan length is of keen interest to asset managers responsible for optimizing asset productivity, and to finance officers trying to make the best use of the firm's assets. For more on this lifespan, see the section below Asset Economic Life.
2. Asset Depreciable Life
Government tax authorities prescribe the depreciation lifespan for different asset classes, sometimes allowing owners to choose a depreciation lifespan from available options. For more on this lifespan, see the section below Asset Depreciable Life.
3. Asset Service Life
Service life may coincide with economic life or depreciable life, or it may end long before or long after the other lives. Service life length is often an arbitrarily chosen number of years or months. For more on asset service life, see the section below Asset Service Life.
4. Asset Ownership Life
The ownership life concept is the organizing basis for Total cost of ownership" (TCO ) analysis—methods for uncovering total costs that follow from owning assets. For more on asset ownership life, see the section below Asset Ownership Life
Other Asset Lives
It is worth mentioning that asset lives with other names are sometimes useful. For instance:
Asset Useful Life
The asset useful life concept is used primarily by tax authorities and accountants to determine the appropriate depreciable life for certain capital assets. The term refers to the number of years the asset can be expected to earn income or otherwise contribute value to a company. For asset life cycle management purposes, however, asset managers generally prefer to work instead with the concepts economic life, service life, and ownership life.
Companies that buy and hold bonds or stock shares from other companies evaluates the performance of these assets with investment metrics, such as Yield to maturity, ROI, IRR, NPV, and Payback Period. To have meaning, these metrics must refer to a time period known as the Investment life. This investment life concept applies especially to purchases of securities such as stock shares or bonds, but the concept concept is also used—albeit less frequently—for other kinds of assets. Investment life is defined as the same way as ownership life: Life begins with the investment's first financial impact and ends with its last financial impact.
Tax authorities occasionally use the term depletion life to refer to the depreciable life assets such as a mines or other natural resource deposits, These assets lose value over time as the resource is used up (depleted).
- How long is Asset Life?
- Asset Lifespan 1: Economic life.
- Asset Lifespan 2: Depreciable life.
- Asset Lifespan 3: Service life.
- Asset Lifespan 4: Ownership life.
The number of years in which an asset returns more value to owners than it costs to own, operate, and maintain, defines its economic life. When these costs exceed the value of asset returns, the asset is beyond its "economic life."
To predict an asset's economic life, owners must first define the specific kind of value they expect the asset to return, and then project the asset's ability to deliver returns into the future. With an economic lifespan estimate in hand, owners can then calculate investment metrics such as "Net present value,""Internal rate of return," and "Return on investment."
Likely economic life is a core consideration in asset planning and when making asset acquisition decisions. The lifespan 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 in comparison to more current alternatives.
- Changes in operations, products, or business model.
These factors can reduce the value certain assets can deliver.
The timespan over which an asset can lawfully depreciate to its salvage value defines its depreciable life.
Each year of depreciable 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 an income tax savings for owners.
At the end of depreciable life, 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. Governments allow asset owners to "expense" costly assets over time as a way of recognizing the accounting matching concept. With depreciation expenses over time, owners match earnings from assets with the expenses that brought them.
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 percent of an asset's original purchase price. Residual value may 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 United States, for instance, computing hardware has a stated depreciation life of 5 years. And, its depreciation must follow the MACRS (Modified Accelerated Cost Recovery System) depreciation schedule.
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 time that ownership has financial consequences of any kind.
- Ownership life begins when the decision to acquire the asset starts causing costs. Some of these costs may appear before the 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 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.
Asset ownership life is the organizing basis for Total cost of ownership" (TCO ) analysis—methods for uncovering total costs that follow from owning assets.