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Estimating The Useful Life of Fixed Assets – How Long Will It Last?

April 10, 2018

Estimating The Useful Life of Fixed Assets – How Long Will It Last?

Synopsis
4 Minute Read

At one point or another, a business owner will ask “what is the useful life of a fixed asset?” The question is relevant in the context of capital expenditure planning, or maintaining and growing operations.

Insight
Insight

At one point or another, a business owner will ask “what is the useful life of a fixed asset?” The question is relevant in the context of capital expenditure planning, or maintaining and growing operations. Lenders are also interested in the remaining useful life (the period of time (or total amount of activity) for which the asset will be economically feasible for use in a business) of a business’ equipment. They want the useful life of the equipment to exceed the length of the loan(s). Lenders are therefore interested in measuring economic depreciation and determining the fixed asset’s value.

In the context of fixed asset appraisals, there are three main methods of appraisal, namely the sales comparison approach, cost approach and income approach. When dealing with custom-made fixed assets in a production facility, the cost approach is typically applied to value such assets.

Assuming that the useful life of a fixed asset is 12 years and that the subject’s asset has amassed three years, it is logical to conclude that under normal conditions (without being rebuilt or modified), the physical deterioration is approximately 25 percent ([3 / 12] x 100 percent = 25 percent]). Although this is a straight-line depreciation calculation for appraisal purposes, the accounting depreciation may be different and unrelated to how the appraiser approaches the concepts of age and life.

When estimating the effective age, the appraiser considers the effect that overhauls, rebuilds and maintenance may have on the asset’s current condition. If a fixed asset is subject to preventative maintenance planning or regular overhauls, its effective age will normally be less, often significantly less, than its chronological age.

The useful life corresponds to the estimated number of years that a new fixed asset will be used before it is retired from service. A fixed asset’s useful life relates to how long similar fixed assets tend to be used, as opposed to the more theoretical economic life calculation of how long a fixed asset can profitably be used.

As part of the inspection and market research, significant reliance is placed on useful life statistical and actuarial data derived from the study of fixed assets. For example, the American Society of Appraisers publishes data ranging from aerospace and defense industries to wood, paper and paper products industries.

There is no simplistic methodology to determine the useful life of an asset.The only certainty is that disclosures in the financial statements will rarely provide valuable insights regarding how long an asset will last.

For more information on how MNP can help, contact Paul Leung, ASA, MRICS at 708.401.7079 or at [email protected] or Dany Le, CPA, CMA, CBV at 780.401.7078 or at [email protected].

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