Useful Economic Life of an Asset
The length of the depreciation period for an asset is closely linked to the useful economic life of that asset. The enterprise must therefore give careful consideration to the length of the useful economic life. This will be linked to the amount of physical wear and tear that will be sustained by the asset, and the enterprise will have to take into account the extent to which it is to be used in the business and the pattern of use. In estimating the economic life of the asset, the enterprise can take into account the level of maintenance and repair that will be received by the asset and the average useful life of that type of asset generally.
Depending on the type of industry in which it operates, the enterprise may need to take into account the length of time likely to elapse before the asset is obsolete and needs to be replaced by a more advanced model. Also, depending on the goods or services that the asset will be helping to produce, the enterprise may need to consider the length of time that will pass before the product that the asset is designed to make goes out of fashion, or before demand goes down because the needs and tastes of customers have changed.
For a specialized asset such as a machine that is devoted to producing one particular line of goods, the above considerations regarding obsolescence should be taken into account, and the depreciation period should be shortened if necessary. The danger is that if the asset, though still in good operating condition, falls out of use because demand goes down, it will continue to be depreciated while it is no longer of use in earning profits. In a high-tech industry where new models appear every year or two, depreciation periods of machines and equipment are always likely to be low because of these considerations.
For an asset such as a building that can be easily switched from one use to another, these considerations of obsolescence are not so relevant, though for certain specialized types of building they must be taken into account.