The effect of useful life on depreciation is something that everyone who claims depreciation on various types of property should understand. While this effect does not alter the total amount of depreciation that may be claimed for the property over time, it may impact how much depreciation can be claimed within a given tax period. Understanding the impact of useful life on depreciation is especially important if tax agencies revise what is considered the useful life of an asset, since it will make a difference in how much depreciation may be claimed on an upcoming tax return.
In order to understand the effect of useful life on depreciation, it is important to know what is meant by a useful life. As it relates to property used in business settings, useful life refers to the total number of years that property is anticipated to remain functional and useful to the business. For each year of that useful life, business owners may claim a certain amount of depreciation for the property. Typically, tax agencies provide tables that identify both the types of property that may be depreciated for tax purposes, and the amount that may be claimed in a given tax year.
Since many tax agencies base those tables to allow for the original purchase price the property in relation to the number of years it can reasonably be expected to remain useful, any changes in the depreciation schedule or table will make a difference on how much depreciation can be claimed. For example, if a company purchases a vehicle for $15,000 US dollars (USD) and the tax agency decrees that vehicle has a useful life of five years, the owner may claim $3,000 USD depreciation on that vehicle on each annual tax return, until five years have passed. Should the agency revise the table so that the useful life of that vehicle is considered four years instead of five, the owner will have to subtract any depreciation already claimed and follow the new table in claiming depreciation in the remaining years.
In this example, the effect of useful life on depreciation relates to how much depreciation may be claimed during any of those remaining for years. This means that if the owner had already claimed depreciation under the previous schedule for two years, there would be a need to recalculate the remaining depreciation by deducting the $6,000 USD already claimed, leaving a total of $9,000 USD subject to depreciation. With only two years left to claim depreciation under the new schedule, this would mean the owner would claim $4,500 USD in annual depreciation rather than the $3,000 USD allowed under the older schedule.
The effect of useful life on depreciation may also involve understanding any salvage value that the tax agency may place on the property. Salvage value is simply what the tax agency thinks the property could be sold for at the end of its useful life. Some tax agencies subtract this amount from the purchase price on the front end, which in turn affects the amount of depreciation that can be claimed each tax year. Other nations do not factor in the salvage value when creating depreciation schedules, especially on property with a purchase price under a certain amount.
