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Estimated Useful Life

The estimated useful life of the asset is of critical importance as a determinant of depreciation. Useful life of an asset is the estimated economic or commercial life of the asset. Physical life is not important for this purpose because an asset may still exist physically but may not be capable of commercially viable production.

For example, a machine is purchased and it is estimated that it can be used in production process for 5 years. After 5 years the machine may still be in good physical condition but can't be used for production profitably, i.e., if it is still used the cost of production may be very high. Therefore, the useful life of the machine is considered as 5 years irrespective of its physical life.

Estimation of useful life of an asset is difficult as it depends upon several factors such as usage level of asset, maintenance of the asset, technological changes, market changes, etc.

As per Accounting Standard - 6 useful life of an asset is normally the “period over which it is expected to be used by the enterprise”.

Normally, the useful life of the asset is shorter than the physical life. The useful life of an asset is expressed in number of years but it can also be expressed in other units, e.g., number of units of output (as in case of mines) or number of working hours. Useful life depends upon the following factors:
  • Pre-determined by legal or contractual limits, e.g. in case of leasehold asset, the useful life is the period of lease.
  • The number of shifts for which asset is to be used.
  • Repair and maintenance policy of the business organisation.
  • Technological obsolescence.
  • Innovation/improvement in production method.
  • Legal or other restrictions.

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