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This may be out of topic for p7, but just out of curiousity, if a company buys a factort for example, how do company know its useful lives ? How do they determine the useful lives and the residual value ?
Is it estimated by the accountants within the firm or by an external auditor or independent reviewer ?
Depreciation is an accounting estimate – based on management’s judgment of useful life and residual value. The auditor has to obtain sufficient appropriate evidence to confirm that accounting estimates are not materially misstated.
Image you are a finance director and the company just bought 3 computers, 5 delivery vehicles, a warehouse and a factory. What factors will you consider when deciding what their useful lives might be? 3 years? 8 years? 20 year? 50 years? What residual value might you expect? $0? Something other than $0? (Remember that an accounting estimate is just that – so, for convenience, many companies assume no residual value on many assets as accounting on a straight-line basis is quicker/easier than on a reducing balance basis – remember the basis is also an element of the estimate.)
Management should have sufficient expertise within the firm (a qualified accountant) to make such estimates. Remember that if the external auditor were to make such an estimate it would, like valuation services, create a self-review threat – so no, the auditor’s job is to audit management’s estimates, not make management’s estimates.See also my post here https://opentuition.com/topic/valuation-depreciation/ which is of some relevance.
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