The famous phrase, all good things come to an end, unfortunately, also holds true for company assets. For businesses to record assets accurately and plan effectively, it is essential to estimate the expected lifespan of items and accurately factor in their depreciation in value over time.
Salvage value is the projected value of an item when it is no longer useful. Depreciation is determined using a salvage value calculation. The formula takes into account the purchase price and the estimated salvage value. Salvage value is also called residual value and can include scrap value.
Since assets deteriorate at varying rates, there are several ways to calculate salvage value. Let’s go through some easy-to-understand salvage value definitions and, most importantly, how to calculate it.
What Is Salvage Value?
While a few assets like antiques or fine artwork may appreciate over time, the value of most fixed assets like company vehicles and office equipment begin to decrease immediately. Keeping track of the salvage value of business assets is a savvy way to reduce taxes and budget effectively for when items need to be replaced.
What Are The Different Types Of Salvage Values?
Terms like salvage value and depreciation can be intimidating until you know how they fit together. One cannot expect the office printer to last as long as a wooden desk. Salvage values of assets, therefore, need to be calculated individually as items depreciate at different rates.
The salvage value formula can take several forms. Some calculate at a set predictable rate across the projected lifespan of an item, while others incorporate ways to include the actual rate of deterioration of assets.
When estimating the salvage value of assets, it is essential to understand the following terms and methods.
1. Resale Value
Resale value is defined as the predicted value of an asset. An asset’s resale and salvage value may be the same at the end of an asset’s usefulness to a company.
Another term for resale value is book value. Book value is often used when determining the value of cars since they depreciate at varying rates, and resale value may depend heavily on condition and accumulated mileage.
2. Salvage Value
Salvage value is the bottom line of what an asset is worth in monetary terms when it is no longer useful. It can also include scrap value which is when an asset is sold off in parts or components.
3. Depreciation Value
Depreciation records the natural declining loss of value of assets over time. One cannot expect that the salvage value of a car will be worth the same amount after two years as it was when it was new.
When estimating the salvage value of an asset, one needs to work out the depreciation of the item over an expected period. Depreciation refers to the decrease in the inherent value of assets over time.
4. Residual Value
Residual value is a synonym for salvage value. It is the amount of value left in an item after it has reached its expected period of usefulness to a company.
Residual value may also be called scrap value if an item is no longer usable. Even broken or damaged assets may retain some physical value and be sold off as components, such as scrap metal.
5. Declining Balance Method Salvage Value
Some assets decline in value faster than others. The declining balance method of calculating salvage value takes this into account and gives bookkeepers a way to reflect the accelerated depreciation.
Instead of dividing up the years you expect an asset to be useful and spreading the depreciation equally over the period, assets are depreciated faster in the first few years and less in the final years. This method is particularly useful for items that lose a lot of value shortly after purchase.
6. Straight Line Method Salvage Value
To use the straight-line method to calculate salvage value, you need to gather three pieces of information:
- The initial cost of the asset
- How long is the expected useful life of the asset?
- How much will the asset be worth at the end of its lifespan? (Salvage value)
Use the following formula to calculate the asset’s rate of depreciation using the straight-line method:
Depreciation Value = (Initial cost – Salvage value) / Assets usefulness
Let’s use the example of new office computer equipment. If it was purchased for $30 000 and you expect it to last for five years. After five years, you anticipate your salvage amount as scrap parts will be around $2000.
$5600 (depreciation value per year) =($30000 – $2000) /5 years
The depreciation amount obtained from the calculation is the amount that can be deducted from the income statement each year until its lifespan is up.
7. Accumulated Depreciation Salvage Value
Accumulated depreciation is a type of flipped-over version of the straight-line method to calculate salvage value. Instead of showing the regular gradual decrease in value of an asset over time, it records the gradual decline of value in monetary terms to a specific date.
The depreciation of the asset is recorded on the credit line below the related asset. For example, a company car may decrease in value faster than expected if it is used frequently, and thus the vehicle’s actual book value will drop more quickly than estimated.
Some important points to know about accumulated depreciation:
- This method is known as a contra asset as it effectively reduces the value you can expect to receive for an asset on the balance sheet.
- The amount can never exceed the original purchase price of the item.
Accumulated depreciation can be calculated as follows:
Accumulated Depreciation = [(Initial cost -Salvage Value) / Projected years of usefulness] x Actual useful lifespan
How Do You Calculate Salvage Value?
- Initial cost -depreciation rate x projected lifespan of the asset = SALVAGE VALUE
Formulas on their own can be confusing, so let’s use an example of a large asset like a new company car. Vehicles have varying depreciation rates depending on factors like the make and usage. One would expect a pizza delivery van to depreciate faster than a car owned by a law firm.
So using the salvage value calculator above, let’s work out the salvage value of a car with an initial cost of $50 000.
|Initial cost||–||Depreciation rate||X||Projected number of years||=||Salvage Value|
|Company car – include additional costs like delivery, registration costs, company branding, etc.||MINUS||How often the car is used, wear and tear, and resale value.||MULTIPLIED|
|The length of time the car is expected to last. For our example, we will use five years.||EQUALS||The amount the car could be sold for at the end of its projected lifespan.|
$ 50 000
|–||$9000 per annum X 5 years||=||$5000|
So each year, the asset can lose $9000 of its initial value in the books as the car is no longer worth what it was when it was new. Take note that an asset can also have a salvage value of zero at the end of its projected lifespan.
Frequently Asked Questions
What Is Salvage Value?
Salvage value is the amount you can expect to get for an asset after it is finished being useful to your business. The inherent monetary value left in the items and what they could be sold for is called salvage value.
It may also happen that the anticipated or realistic salvage value of items is zero at the end of the useful period. For example, company uniforms may change and cannot be sold or reused. Salvage value is also called residual value or scrap value.
How Is Salvage Value Calculated?
The salvage value of an asset is determined as follows:
Initial purchase price – Depreciation over time (from things like condition/getting outdated/mileage on cars etc.) = Salvage Value.
What Is The Difference Between Asset Depreciation And Salvage Value?
Asset depreciation is a factor affecting the ultimate salvage value of an asset. It describes the process or rate at which an asset loses value.
Let’s use the example of a company car. Car salvage value is the amount the business could reasonably expect to sell the vehicle for at the end of its projected lifespan. Between the time it was initially purchased and the salvage date, it will be depreciating. This could be because of mileage, wear-and-tear, or newer models being released.
What Is The Depreciation Rate?
The depreciation rate is the expected rate at which an asset loses value. It will be different for each asset or asset type, and many factors affect the depreciation rate.
For example, you could expect a solid oak office desk to last indefinitely, but a company car used daily will have a much faster depreciation rate.
What Is The Difference Between Tax Salvage Value And Scrap Value?
The way an asset is disposed of affects whether it will have a tax salvage value or be written off at the projected salvage value. Let’s take a look at the difference:
- Scrap value – An asset is sold off for the amount projected, or it may even need to be written off if no buyers are found.
- Tax Salvage Value – The asset unexpectedly sells for a profit. The difference between the salvage amount that had been projected and the profit received from the sale must be recorded as profit. That amount is liable for tax.
There is a helpful salvage value calculator that can make determining salvage value simple. The formula for calculating salvage value is:
Salvage Value = (Initial cost -depreciation) x projected usefulness of the asset
What Is The Effect Of Salvage Value On Accounting Books?
By knowing the depreciation rate and salvage value of items, bookkeepers can keep track of the decline in the value of company assets. Depreciation is tracked and included during the accounting process.
The final possible salvage value is the anticipated monetary value the company can expect to obtain when disposing of the asset at the end of its useful lifespan.