Definition
The term economic life is defined as the timespan over which the annual cost of owning and operating an asset is minimized. The economic life of an asset can be a function of factors such as physical wear and tear, as well as technological obsolescence.
Explanation
The concept of economic life is important to both accountants as well as the operators of the asset. For example, Generally Accepted Accounting Principles would suggest the book depreciation of an asset occurs over the same timespan as its economic, or useful, life. In the same way, the operator of an asset should plan for the purchase of a replacement when the asset has reached the end of its economic life.
The economic life of an asset may be determined in a number of ways. For example, the physical wear and tear that occurs in a machine over time may limit its economic life. Minor repairs are no longer sufficient to keep the machine in service, and a replacement lowers the company's overall operating costs.
Economic life may also be a function of technological obsolescence. For example, a company's information technology group may be able to keep a computer system running for many years; however, the processing speed of the computer may no longer be adequate to meet the demands of modern-day software programs. In this second example, the physical life of the equipment is much longer than its economic life.
Note: To foster investment, tax law oftentimes allows companies to accelerate the depreciation of an asset, thereby providing the owner with a near-term tax savings benefit. For this reason, a tax depreciation schedule may be compressed relative to the book depreciation that appears on the company's balance sheet.
Related Terms
- The financial accounting term operating lease is used to describe one of several lease arrangements that a company can hold. Operating leases are used to acquire assets on a relatively short-term basis. The cost of an operating lease appears as an expense on the income statement.
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The Financial Accounting Standards Board rules allow companies two methods to account for leases. If the agreement meets any of the following conditions, the lease should be treated as a capital lease, also known as a finance lease:Moneyzine EditorNovember 6th, 2024
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The term minimum lease payment refers to the lowest possible payments a lessee is obligated to make in connection with an asset over the term of an agreement. Minimum lease payments can include rent, residual value, penalties, as well as a bargain-purchase option.Moneyzine EditorFebruary 8th, 2024- The financial accounting term unguaranteed residual value refers to the worth of a lease property at the end of the agreement's term that is not the responsibility of the lessee. Unguaranteed residual values do not qualify as a financial obligation of the lessee, and do not factor into the calculation of the minimum lease payment.Moneyzine EditorSeptember 21st, 2023
The financial accounting term guaranteed residual value refers to an additional payment made by a lessee in property, cash, or both when a lease terminates. Guaranteed residual values are financial commitments made by the lessee, and factor into the calculation of the minimum lease payment.Moneyzine EditorJanuary 19th, 2024
