Useful Lives and Salvage Values as Estimates

Introduction

In January 2023, Alphabet concluded that its servers would last six years rather than four, and that certain network equipment would last six years rather than five. Nothing physical changed in its data centers. The decision alone reduced its depreciation expense for 2023 by $3.9 billion and raised its net income by $3.0 billion, or $0.24 per share, according to its 2023 annual report. Its cash flow did not change at all.

Useful lives and salvage values are two of the most consequential estimates in accounting. Together with the depreciation method, covered in depreciation methods, they decide how quickly the cost of an asset reaches the income statement. Because they are judgments rather than measurements, they can be revised, and each revision moves earnings in the years that follow. For companies with large asset bases, a one-year change in assumed lives can be worth billions.

Straight-line depreciation is the asset's depreciable cost divided by its useful life:

Useful life

The period over which an asset is expected to be available for use by the company, or the number of units it is expected to produce. It is a management estimate, based on physical wear, technological obsolescence, legal or contractual limits and the company's planned use, and it can be shorter than the asset's physical life.

The useful life sets the denominator of the calculation; the salvage value reduces the numerator, because the part of the cost the company expects to recover on disposal is never consumed and so is never depreciated. A $1,000 machine expected to last nine years and sell for $100 at the end is depreciated by $100 a year, not the roughly $111 that ignoring the salvage value would give.

Salvage value

The amount a company expects to receive from disposing of an asset at the end of its useful life, net of the costs of disposal. Also called residual value, it is deducted from cost to determine the amount to be depreciated, and it is revised when expectations change.

For most equipment, salvage value is small or zero; for assets with active secondary markets, such as aircraft, trucks and rental cars, it can be a large share of cost, and changes in used-asset prices can move it materially. A rental car company that assumes its vehicles will be worth half their cost after two years, and then sees used-car prices fall, must either raise depreciation on the remaining fleet or record losses when the cars are sold.

Both estimates draw on the same evidence: the company's own experience with similar assets, manufacturers' guidance, industry practice, technological change and its plans for the asset. A server may still work after eight years but be uneconomic to run after five because newer machines are far more efficient; its useful life to the company is the shorter period. ASC 360 expects companies to review these estimates when circumstances change.

A revision to a useful life or salvage value is a change in accounting estimate under ASC 250. It is applied prospectively: the asset's remaining net book value is depreciated over its revised remaining life, and prior years are not restated. Suppose a company buys an asset for $1,200 with no salvage value and a four-year life, so depreciation is $300 a year. After one year, with $900 of net book value left, it concludes the asset will last six years in total, five more:

Depreciation falls by $120 in each of years two to four and rises by $180 in years five and six, when the original schedule would have finished. Total depreciation is the same $1,200; only its timing changes. At a 25% tax rate, net income rises by $90 a year for three years. Because tax depreciation follows its own schedules, unaffected by the book estimate, the lower book depreciation creates a deferred tax liability rather than any change in cash taxes, the mechanism traced in depreciation on the three statements.

When Lives Get Shorter

Revisions run in both directions. When a company decides to close a plant, exit a store or retire equipment earlier than planned, it shortens the remaining lives of the affected assets, so their remaining book value is depreciated over the months before retirement. This accelerated depreciation often appears in restructuring charges, because it relates to decisions to exit activities, and bankers usually treat it as non-recurring. Shortening can also reflect technology: Amazon cut the life of a subset of its servers and networking equipment from six years to five from 2025, anticipating a reduction of about $0.7 billion in that year's operating income, and its 2024 annual report attributed the change to the faster pace of technology development, particularly in artificial intelligence and machine learning. A shortening is the mirror image of an extension: higher depreciation now, lower later, and no change in cash.

Disclosure of Changes

When a change in estimate has a material effect, ASC 250 requires the company to disclose its effect on income from continuing operations, net income and earnings per share for the current period. That is why Alphabet quantified the $3.9 billion reduction in depreciation and the $0.24 per share effect. Companies also describe their ranges of useful lives by asset class in the property, plant and equipment (PP&E) note, which is where bankers compare policies across peers.

For companies with large asset bases, the sensitivity is substantial. Union Pacific discloses in the critical accounting estimates section of its 2025 annual report that if the estimated useful lives of all its depreciable assets were one year longer, annual depreciation would fall by about $81 million, and if they were one year shorter, it would rise by about $76 million, against total depreciation of about $2.5 billion. Either way, a one-year change moves the charge by only about 3%, because railroad track and equipment are depreciated over decades: the longer the lives, the smaller the effect of adding or removing a year.

Technology companies face larger swings, because their equipment lives are short and their spending is enormous. Extending a four-year life to six cuts annual depreciation on new assets by a third; reversing such a decision raises it by half. With the largest technology companies now spending hundreds of billions of dollars a year between them on servers and data centers for artificial intelligence, the assumed lives of that equipment have become a significant driver of their reported earnings, a debate examined in useful lives and the AI capex debate.

Bankers look at three things. First, the direction of changes: a 2014 Audit Analytics study of 558 changes in the useful lives of depreciable assets disclosed since late 2007 found that in five of the preceding seven years, changes that increased income outnumbered those that reduced it. Life extensions are not wrong, but a pattern of them deserves scrutiny. Second, comparison with peers: two companies depreciating similar equipment over four and six years will report very different earnings before interest and taxes (EBIT) for the same economics. Third, the gap between book and economic lives: if assets are being retired well before the end of their depreciable lives, losses on disposal or impairments will eventually catch up with the earnings flattered by long lives.

For valuation, EBITDA-based approaches are insulated from these estimates, while EBIT, earnings per share and price-to-earnings multiples are not. When a company changes its lives during the period being analyzed, bankers usually adjust the affected years to a consistent basis in their analysis, so that growth reflects the business rather than the accounting. The treatment of such changes in comparative periods is covered in restatements and accounting changes.