Business owners need to know whether or not costly assets justify their presence in the asset base. Owners expect assets to produce returns of one kind or another that exceed their costs. Assets that underperform in this way are candidates for replacement or disposal. Assessing asset performance for this purpose is part of the discipline known as Asset Lifecycle Management (ALM).
ALM is built from the asset lifespan concept. This is the idea that each asset is living seral different lives, simultaneously, and that each life has a lifespan of its own, defined by definite begininning and end points.Classical ALM deals with four asset lives in particular:
These lives and their lifespans are the primary subject of this article.
Who Uses the Asset Lifecycle Concept?
ALM methods produce metrics and directions that guide managers through asset planning, acquisition decisions, deployment, optomization, use, and disposal. The asset lifespan concept is a primary focus for:
- Asset Managers:
People with the title "Asset Managers" are responsible for optimizing all aspects of asset performance across an organization. To excel in this role, they must understand how the lengths of the four asset lives are determined .
- Business analysts.
Asset ownership life is the organizing basis for Total cost of ownership" (TCO ) analysis—methods for uncovering total costs that follow from owning assets.
Acountants maximize the firm's potential income tax savings from depreciation expense across asset depreciable life.
- Finance Officers.
Finance officers use economic life and service life concepts to maximize the firm's Return on Assets (ROA).
- How long is asset lifespan?
- Asset Life 1, Depreciable Life.
- Asset Life 2: Eeconomic life.
- Asset Life 3: Service life.
- Asset Life 4: 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 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 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 likely 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 in comparison to more current alternatives.
- Changes in operations, products, or 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 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 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.