When a business acquires a fixed asset, it estimates the asset’s useful life—the period over which the asset will provide economic benefits. However, due to changes in technology, usage patterns, or maintenance conditions, businesses may need to revise the remaining expected life of an asset. This change affects future depreciation calculations and financial reporting. Below, we explore the reasons for adjusting an asset’s useful life, how to recalculate depreciation, and the accounting treatment.
1. Reasons for Changing the Remaining Expected Life of an Asset
A. Technological Advancements
Rapid advancements in technology may shorten an asset’s useful life, making it obsolete sooner than expected.
B. Changes in Usage
If an asset is used more intensively than planned, its useful life may decrease. Conversely, reduced usage may extend its lifespan.
C. Improved Maintenance
Regular servicing and repairs can extend an asset’s useful life beyond its original estimate.
D. Changes in Business Operations
Companies may revise an asset’s useful life due to shifts in business strategy, such as downsizing or expanding operations.
E. Legal or Environmental Regulations
New regulations may require businesses to phase out certain assets earlier than planned.
2. Accounting Treatment for Changes in Asset Life
When an asset’s remaining life is revised, the change is applied prospectively—meaning past depreciation remains unchanged, and the new estimate affects only future depreciation.
Formula for Adjusted Depreciation
New Annual Depreciation = (Current Book Value – Residual Value) ÷ Revised Remaining Useful Life
- Current Book Value: The asset’s value after accumulated depreciation.
- Residual Value: The estimated salvage value at the end of its life.
- Revised Remaining Useful Life: The newly estimated years of use.
3. Example of Changing the Expected Life of an Asset
Scenario:
- A company purchases a machine for $100,000.
- The initial estimated useful life is 10 years.
- The asset has a residual value of $10,000.
- The company uses the Straight-Line Depreciation Method.
Step 1: Calculate Original Depreciation
Annual Depreciation = (Cost – Residual Value) ÷ Useful Life
= ($100,000 – $10,000) ÷ 10
= $9,000 per year
Step 2: Determine Book Value After 5 Years
Accumulated Depreciation = 5 × $9,000 = $45,000
Book Value = Cost – Accumulated Depreciation
= $100,000 – $45,000 = $55,000
Step 3: Change in Remaining Useful Life
The company reassesses the asset and estimates it will now last for 7 more years instead of 5.
Step 4: Recalculate Depreciation
New Depreciation = (Book Value – Residual Value) ÷ Revised Remaining Life
= ($55,000 – $10,000) ÷ 7
= $6,429 per year
Step 5: Journal Entry for Adjusted Depreciation
Debit: Depreciation Expense $6,429
Credit: Accumulated Depreciation $6,429
4. Impact of Changing the Asset’s Useful Life
A. Balance Sheet
- The asset’s book value remains unchanged; only future depreciation changes.
- Accumulated depreciation continues to increase.
B. Income Statement
- Annual depreciation expense decreases (or increases) based on the new estimate.
- Net income may improve if depreciation decreases.
C. Cash Flow Statement
- Since depreciation is a non-cash expense, the cash flow statement is not directly affected.
5. Advantages of Revising an Asset’s Useful Life
- More Accurate Financial Reporting: Ensures that depreciation reflects the asset’s actual lifespan.
- Better Decision-Making: Helps businesses manage asset replacement strategies.
- Tax Benefits: Adjusting depreciation may reduce taxable income in certain years.
6. Disadvantages of Revising an Asset’s Useful Life
- Complex Adjustments: Requires continuous asset reassessment.
- Potential Investor Concerns: Frequent changes may raise questions about asset management.
7. When Should a Business Change the Remaining Life of an Asset?
- If the asset is used more or less than originally expected.
- When technology changes impact the asset’s viability.
- If maintenance efforts extend or shorten the asset’s lifespan.
Ensuring Accurate Depreciation with Asset Life Revisions
Revising the remaining expected life of an asset ensures that depreciation aligns with its actual usage. By making prospective adjustments, businesses improve financial accuracy, optimize tax planning, and enhance asset management strategies.