The period over which an asset, such as equipment used in a business, is expected to last. This concept historically was used to determine tax depreciation deductions for the purchase of assets. It may still have important relevance in valuing a business, or in negotiating the structure of a bonus for an executive or other employee. For example, if you have a pain center associated with your medical practice and you wish to compensate the pain physician for profits from the pain center, how do you calculate profits? If the tax laws permit you to deduct the purchase of equipment in the year of purchase do you deduct that full amount in calculating profits? In the alternative, would you include in the employment or partnership agreement that you would instead amortize that purchase price over the useful life of the equipment to more reasonably allocate the cost to each year? The argument in favor of this is that it is a better measure of economic profits. On the other hand, if the business has expended the cash in the year of the purchase, will you have the cash flow to pay a bonus to the pain physician. The same concept can be applied in a host of businesses. The key is to carefully think through how expenditures impact bonuses, and other compensation structures.
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