Fixed assets are normally referred to as property, plant, and equipment with a useful life of more than one year. In order words, they are expected to be converted into cash in more than one year due to their usages.
Fixed assets costs are not directly charged into the entity’s income statement immediately when purchasing. But the costs will be charged as depreciation expenses in the systematic depreciation methods over the useful life of assets.
Useful life, depreciation rate, depreciation methods, and a residual value of assets are the factors that affected the amounts of depreciation expenses during the periods.
Based on IAS 16, Useful life is:
(a) The period over which an asset is expected to be available for use by an entity; or
(b) The number of production or similar units expected to be obtained from the asset by an entity.
To ensure that the assets’ useful life is defined accurately over the life of assets, an entity should at least review useful life one per year. This will help to ensure that the depreciation charges are accurately and reflected in the economic value that asset contributes to the entity. And assets stated in the balance sheet are at their fair value.
When an entity reviews its asset’s useful life and found that the useful life is changing, the entity should account for the change according to the IAS 8 Accounting Policies, Changes in Accounting Estimates, and Errors.
Useful life assets can be shorter or longer than economic life assets. For example, the computer can be used for five years, but the entity could determine the useful life of computers based on its experiences or policy for three years.
Some assets like lands have an indefinite useful life, not like building and other assets. Buildings have limited useful life, and therefore they are depreciated. Lands are not depreciated because they have an indefinite useful life.
Assessing the useful life of a fixed asset is an important part of financial reporting under International Accounting Standard (IAS) 16, Property, Plant and Equipment. The useful life of an asset is the period of time over which an asset is expected to be available for use by an entity and is used to determine the pattern of depreciation for the asset.
Tips to assess the useful life of fixed assets under IAS 16
Here are some tips for assessing the useful life of fixed assets in detail:
- Physical wear and tear: The expected physical wear and tear of an asset should be considered when assessing its useful life. This includes factors such as the frequency and intensity of use, exposure to the elements, and any expected maintenance or repairs. The actual wear and tear on the asset should be monitored and compared to expectations to ensure the useful life estimate is still accurate.
- Technological obsolescence: Technological advancements can render an asset obsolete, and this should be considered when assessing its useful life. The useful life of assets that are subject to rapid technological change, such as computers or production equipment, may be shorter than that of assets that are not subject to such change.
- Replacement plans: An entity should consider any plans for replacement, renovation, or significant modifications of an asset when assessing its useful life. For example, if an entity plans to replace an asset after five years, the useful life of the asset would likely be considered to be five years.
- Industry practice: The experience of similar assets and industry practice should be considered when assessing the useful life of an asset. Industry practice may be a useful benchmark, particularly for assets that are widely used in a particular industry.
- Contractual arrangements: Any warranties, maintenance contracts, or other contractual arrangements that may impact the useful life of an asset should be considered. For example, a warranty that covers repairs for five years may indicate that the useful life of the asset is five years.
- Economic, legal, and environmental factors: The effect of economic, legal, and environmental factors that may impact the useful life of an asset should be considered. For example, changes in laws or regulations may limit the use of certain assets, such as environmental restrictions on the use of certain chemicals.
- Actual performance: The asset’s actual performance and any indications of its declining performance should be reviewed regularly. If an asset is not performing as expected, it may have a shorter useful life than previously estimated.
The useful life of an asset is an important factor in determining the pattern of depreciation and should be reviewed regularly and updated if necessary. Assessing the useful life of an asset requires a thorough understanding of the asset and its expected use, as well as an evaluation of various factors that may impact its useful life.