When a company buys an asset it takes into consideration many things like cost of the asset, use of the asset, life of an asset but out of all things, the life of an asset is the most important aspect as far as business is concerned. Now asset life can be looked from two perspectives one is physical life of an asset and other is economic life of asset, in order to understand both the terms better let’s look at the difference between economic life and physical life –
- While the physical life of an asset means the period for which the asset can provide service to the company whereas the economic life of an asset implies the period for which the asset can provide profitable service to the company. Hence as far as the company is concerned the economic life of an asset is far more important than physical life because companies want to make profits and economic life is relevant when it comes to earning profits.
- An example of physical life will be human beings suppose human being has age of 80 years then his or her physical life will be 80 years whereas in case of companies where retirement age is 60 years the actual economic life of human being is 60 years and not 80 years as they can work only until 60 years for the company. Similarly, in the case of machines if the machine is producing units at profitable margins for the company then it is economical for the company and if it stops producing units at profitable margins than its physical life has no importance for the company.
- An asset physical life will always be greater than assets economic life because asset first fails economically and then physically it becomes useless.
- Assets physical life cannot be extended whereas as far as the economic life of an asset is concerned it can be extended by taking proper care of asset and also through repair and maintenance of the asset.
- The physical life of an asset is affected by wear and tear, improper use and so on whereas the economic life of an asset is affected by technology change, change in consumer tastes and preference and so on. Hence, for example, a mobile handset made 5 years back may still be physically fit to use but due to the advent of the smartphone, it is of no use for an individual.
As one can see from the above that physical life and economic life are completely different from each other and that is the reason why companies before buying any asset should carefully look at both physical and economic life and then decide whether to purchase an asset or not.