Useful life

Definition: The period of time over which a company expects to get productive use out of a piece of equipment it has purchased.

Example: SHP Shipping purchases a $22,000 van to make local deliveries. At the time of purchase, it estimates that the van will give it five years of reliable service. This is its useful life. It believes that at the end of this five-year period, it will be able to sell the van for $2,000, its salvage value.

Investeach explains: In the above example, the total amount of depreciation to be recorded over the five-year useful life is the original cost (ie, cost basis) minus the salvage value: $22,000 – $2,000, or $20,000. The five-year useful life means that under straight-line depreciation, $20,000 / 5, or $4,000 in annual depreciation will be recorded.

With useful life being an estimate, it is possible that equipment can continue to be productive long after the useful life – which was estimated for depreciation purposes – has passed.

Finally, useful life is ignored under Modified Accelerate Cost Recovery System (MACRS), the system the government created to allow companies to use higher depreciation when computing the income taxes they owe.

Riddle me this:

1. How will using an estimate of longer useful life affect the total depreciation to be recorded?
2. How will a longer useful life affect the depreciation that is recorded each year?
3. Why shouldn’t companies throw out or dispose of equipment which has reached the end of the useful life that was estimated at the time the equipment was purchased?