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The economic life of an asset is a measure or forecast of the time remaining during which it will be economically usable. This can be a shorter period than its physical life, as it may reach a point where its running costs outweigh its productivity. The principle of an economic life is the same principle behind depreciation, though the two figures may differ because of legal accounting constraints.
The idea of an asset having an economic life will be familiar to anyone who has scrapped an operational car for reasons other than wanting a new model or giving up driving. A person in the situation will usually have found that the costs of maintaining the car will have increased as it gets older and needs more repairs. It may also have attracted increased taxes or higher insurance premiums. Meanwhile, the car may prove less useful if it has to be driven at slower speeds or spends more time under repair. Eventually the driver will decide that the benefit he or she gets from having the car does not justify the running costs.
A business will see its physical assets in the same way. A machine could theoretically still be useful for several years after it stops producing enough to justify its running costs. A computer could still work but may have slowed down to the point that it isn't productive enough to justify the staff time spent using it.
The economic life is merely a forecast and is based on general, predictable patterns of decline. In reality, unpredictable factors could affect an asset's economic life. A widget-making machine might become unviable overnight if the market price of widgets collapses. Alternatively a government might make it illegal to use a widget-making machine unless its lead parts are replaced with steel.
These types of factors aren't always included in economic life forecasts, but there can be some exceptions. For example, an economist assessing the economic life of an injection mold used to make soda cans and an injection mold used to make a particular cellphone may forecast the economic life of the latter to be shorter. That's because even though cellphones sell for a higher rate, each model is more likely to suffer a drop in sales as it becomes older and even obsolete, making the mold useless. Soda drink markets are likely to remain relatively steady and the mold will probably still be usable even if the popularity of individual brands changes.
I imagine that a good prediction of assets' economic life is important to account for costs. Especially if a business is not running a high profit margin, a sudden loss of machinery might cause it to be at a loss.
Aside from the unpredictable events that might shorten an asset's life, what are some other factors that a business should pay attention to when trying to determine economic life?
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