It is necessary to determine the estimated life of each piece of property, plant, and equipment as it will be used in the entity involved. However, as a matter of expediency, most organizations establish classes or groups of items and depreciate them over a similar life. For example, furniture may be defined as a class and a single life utilized for it. Because it is necessary to project into the future, this is not a simple task. Useful lives of items may be far beyond what the practical or economic life of an item will be.
Automobiles may have a useful life of ten or twelve years. However, in a rental car business, the practice may be to replace an automobile each year, or within two years. Because customers expect to drive new automobiles, the economic life in the rental car business would be no more than two years. The same automobiles used by administrative employees of the rental company may be replaced every three or four years. Past practice should be reviewed in determining the future useful life of the item.
Determining the estimated useful life has a significant impact on the period expenses. Shortening the life will increase expenses in the periods. An estimated life in excess of actual life understates the expenses in those periods and will cause retirement of undepreciated assets. Therefore, careful consideration should be given to ensuring that estimated life and actuals are reasonably accurate.
The past lives of assets, known as mortality or vintage records, can be of assistance. They may not predict the future, but they can serve as a reasonable estimator. Examples are computers and aircraft. Although the possible useful life may be ten years, the technology is improving so rapidly that it is not unusual for a computer to be replaced in two or three years. Aircraft purchased by major airlines in the past were normally replaced as new models became available. The major airlines then sold their planes to smaller airlines, who in turn operated them for a number of years. In recent years, however, the major airlines have elected to retain their planes for longer periods, in order to reduce their cash outflows.
In determining the estimated life, consider the lives of similar items used by the company in the past. A well-defined property record will provide that type of information. Review with the users of the items their expected use in the future. Is it increasing or decreasing? Determine what policies may be changed that will affect the actual life of an item in the organization.
Many small businesses tend to use the lives authorized in the internal revenue regulations for income tax. If these lives are close to what the estimated ones are, that may be a reasonable alternative. However, tax regulations are produced to implement social and economic programs, resulting in accelerated depreciation periods. By replacing assets in accordance with such regulations, a company may replace assets too quickly.