Estimating Useful Lives of Assets
By Timothy H. Baker
Hospital and health system financial statements should accurately reflect the lives of their assets. Whether or not they actually do so is up for debate.
When Medicare was introduced in 1966, it reimbursed hospitals on a “cost-based” structure. Depreciation of assets such as buildings and equipment was one such cost. Therefore, it was beneficial for healthcare providers to maximize depreciation, as greater depreciation equaled greater reimbursement.
Computing the depreciation expense required hospitals to capture the cost or value of the assets, as well as determine the anticipated life of the assets. To calculate the anticipated life, hospitals used the American Hospital Association Chart of Accounts, which in 1966 showed the average useful life of a hospital at 40 years.
From 1966 to 1991, not surprisingly, hospitals did their utmost to maximize depreciation expense for Medicare cost reporting purposes. In 1991, that began to change for two reasons:
- One benefit of rapidly depreciating assets went away when Medicare phased out cost reimbursement from 1991 to 2001, subsequent to the introduction of diagnosis-related groups (DRGs).
- The IRS and others realized that the average useful life of a hospital was longer than 40 years. In many cases, much longer. The same is true with the lives of equipment.
The reality is well-constructed hospital buildings frequently last more than 40 years, often more than 100 years. They are remodeled and/or renovated, or they acquire adjacent land for new construction. So although interior building components may change over time and the functions within the building may change, the structural components remain the same.
So what is the accurate life? Principle Valuation has analyzed the useful lives of more than 400 hospitals and their associated buildings, building components and equipment, relying heavily on engineering analyses that include a wealth of data. That data includes:
- Dates of construction
- Maintenance history
- Effective age
- Estimated remaining life of the building and its components
Principle Valuation’s study provides support for 70-year to 100-year lives for the structural components of a hospital building. This can translate to 40, 45 and in some cases 50 years or more composite lives. In some instances, the actual lives of equipment doubled.
Still, many organizations continue to use an average structural life of 40 years, resulting in depreciation that is too rapid. This causes an ongoing inaccurate and understated reflection of assets’ value on financial statements, and understates their investment value. This can have a major impact on a hospital’s ability to finance, and the term at which it finances.
Of course, every situation is different. Correctly assigning useful lives involves conducting an engineering review of the structural components and physical observation and inspection of equipment. According to the American Institute of Certified Public Accountants, asset life estimates should be changed when new information becomes available through a review of the assets, how they have been used and maintained, and what history shows.
Check out our article in the June hfm Early Edition, “The Truth About Asset Relifing.”