How long you plan to use an asset affects the Depreciation going through your accounts… which means asset lives matter to your Profits and your Balance Sheet.
Assets are depreciated over the period you expect to use them…
If you expect to use a £100,000 asset for 4 years… this year’s Depreciation could be £25,000
If you decide instead you’ll use it for 5 years… this year’s Depreciation could be £20,000
That’s £5,000 extra profits Tax Free… (because Depreciation of Tangible Assets has nothing to do with tax)… and at the end of the year the asset will be carried in your Balance Sheet as worth £80,000 instead of £75,000
Profits up… Balance Sheet strengthened… a win win
All about Judgement
How long you’ll be using the asset is down to you… it’s all a matter of judgement (or educated guesswork)… and you can review asset lives every year...
So when you buy, say, a £100,000 asset you may expect to use it for 4 years… the Depreciation cost each year for the next 4 years will be £25,000
After 2 years it is in your Balance Sheet as an asset of £50,000
BUT… you realise you can now get another 5 years out of it … (perhaps because of repairs you’ve done, or you were being too cautious when you made your original estimate)
… so the Depreciation in year 3 will drop from £25,000 to £10,000 … !
Asset Lives… Definitions
1 The Period over which an asset is expected to be available for use by an entity… or
2 The number of production or similar units expected to be obtained from the asset by an entity
If you bought a £200,000 lorry you may have a policy of selling all lorries after 4 years… in which case you are using definition 1. and will depreciate the lorry over 4 years… so in the first year Depreciation would be £50,000
If instead you have a policy of selling lorries after 100,000 miles, you’re using definition 2…. and if in the first year you clocked up 50,000 miles… then the first year’s depreciation charge would be £100,0000
Repairs & Maintenance do not stop the need to Depreciate assets… but they may change the expected Useful Life of the asset and so will either impact the Residual Value.. or prolong the period that the company will use the asset (and so reduce the Depreciation charge each year)
Useful Life… An asset’s life in this context is not the total expected life of the asset… but the period that the company will get use from it… (“the period from which the entity expects to consume economic benefits from the asset”).
FRS 102 para 17.21 gives 4 points to consider when determining the Useful Life of an asset