Now that you have decided to change the useful lives, there’s that little extra work which needs to be done and you’re all sorted.
We are going to show how to do it through an example – we are changing a laptop’s useful life from 2 years to 3 years. Let’s say that after the first year the laptop with cost price of a 1,000 has been amortized to 500. It has a remaining useful life of 1 year.
As of this the management has estimated that this laptop will still be in use after this year has elapsed and in fact according to management’s best judgment, the remaining period is now 2 years. In fixed assets accounting the cost price is now set as 500, which was the carrying value when the change was done and the useful life is now 2 years. In total the useful life is 3 years, of which 1 has elapsed already.
The very first and obvious answer is „because it’s required to review the useful lives at least once a year“. Should they in reality differ from what has been set for the assets in accounting, they need to be changed in a way they would reflect the real usage once again. This is the “must do” part though. There may also be a need for this change arising from the wish to manage expenses better.
Where it may seem like the actual usage is longer, even just by a year, you don’t feel the need to go through all this fuss with the changes, however in a situation where expenses are under tight pressure by either owners or investors every little helps.
Two major areas where estimates are used in accounting for property, plant and equipment as well as intangibles are their useful lives and residual values. They are important mainly because although they are determined right from the initial recognition, unlike the cost value, they are subject to change when conditions do. The amount you paid in for the property shall rarely change and if so, it’s because you bought some additions to it. But for how long you’ll use the asset and what shall you actually get from selling it – they are subject to change in correlation with macro-economic performance as well as business-wise changes. It’s often ignored however and unintentionally I might add.
There are two sides to the story however. First off the management needs to determine and set their best estimates at the initial recognition. What are the sources of information to use? There is no right or wrong answer here. Usually the estimate for useful lives is done based on the previous experience, industry-wide knowledge and possibly for residual value you’d use the information available in selling ads or similar sources. So, pretending now that you have revisited those estimates (as you are supposed to do as a minimum annually), you understand that both or one of these values needs to be changed. Now what?