Question

How would changes in the estimated life of an asset, for example a building, impact financial reporting and the financial statements of the business?

Answer 1

Life of an asset (basically, in terms of year) is an important aspect in accounting. In case of financial reporting (like management analysis) it is disclosed, and in financial statements (income statement, balance sheet, statement of retained earnings, and cash flows statement) it is required to calculate depreciation expense, accumulated depreciation, book value of the asset, etc.

Suppose an example could be taken; a building is purchased at a cost of $50,000, it has 10 years of life, and have no slavage value at the maturity.

Therefore, the depreciation expense (straigh-line method) = (Cost – Salvage value) / Life years

                                                                                              = (50,000 – 0) / 10

                                                                                              = 50,000 / 10

                                                                                              = $5,000

This depreciation expense is recorded in the income statement in order to get the net income; and such depreciation amount is added to the accumulated depreciation, which ultimately reduces the book value of asset.

Now if the life years have changed, say 10 years to 8 years, the whole senario would be changed. Lower years mean higher depreciation amount, which leads to decrease net income and asset value.

Not only that, the previous years’ adjustments also must be rectified in search of correct figure.

Therefore, a careful estimation is very necessary.