Updated July 17, 2023
Definition of Salvage Value
Salvage value is also known as scrap value or residual value can be defined as an estimated price or value of any non-current asset at the end of its useful life (usually more than one year) or in other words the price which the company will get after utilizing it throughout its useful life by selling in a competitive market where goods can be freely exchanged.
Explanation
Salvage value can be described as the estimated value which a company will realise as a part of terminal cashflow after utilizing asset throughout its useful life. Different valuation techniques are prescribed for salvage value calculation in different applicable accounting standards. Salvage value plays an important role in determining the yearly depreciation charge for an asset. Generally, salvage value is very minimal as compared to its original cost as assets gets fully utilized. The depreciable base is calculated by reducing the salvage value from the original cost to determine the annual deprecation charge.
The formula for salvage value
Here,
- P is the actual value of the asset
- D is the depreciation rate
- n is the number of years
OR
Here,
- P is the actual value of the asset
- D is the depreciation amount
- T is the number of years
How to Calculate the Salvage Value?
- The first step is to determine the actual cost of the machine which is usually the purchase price of the asset added with installation and other such relevant expenses incurred for making the asset put to use.
- Second thing is to determine the applicable rate of depreciation rate as per asset category as mentioned in accounting standard guidelines. The depreciation rate is the rate at which the asset is going to be written off in the books.
- Next, one needs to determine the useful life of the asset for which asset will generate future economic benefits to the entity.
- Lastly, apply the formula Salvage Value = P (1-D)n
Salvage Value and Debitoor
Debitoor is an invoicing and accounting software that is usually used by small traders, freelancers, and other service providers. Whenever recording any transaction, debitoor gives the user an option to choose a transaction as either expense or an asset. When selected as an asset, it requires the user to enter basic inputs like purchase price and other acquisition expenses, class of asset, etc. The software automatically determine salvage value based on the asset class. However, it also gives the user an option to put the residual value and expected lifespan manually and applies the straight-line method of depreciation. Software spreads the cost of an asset over the life span of the asset and charges depreciation accordingly.
Examples of Salvage Value
Following are the examples are given below:
Example #1
Unilever purchased a vehicle costing $10,00,000 with a useful life of 10 years, applicable depreciation is $80,000 per year. Determine salvage value based on given inputs.
Solution:
Here,
- P (cost of asset) = $10,00,000
- D (Depreciation) = $80,000 PA
- T (Time) = 10 Years
Salvage Value is calculated using the formula given below:
Salvage Value = P – ( D * T)
- Salvage Value = $10,00,000 – ($80,000 * 10 )
- Salvage Value = $10,00,000 – $8,00,000
- Salvage Value = $2,00,000
Example #2
Wallmart Inc. purchased machinery costing $8,00,000 and decided to have a depreciation rate of 10% PA for the period of 5 years. Calculate the salvage value.
Solution:
Here,
- P (cost of asset) = $8,00,000
- D (Depreciation) = 10% PA
- n (Time) = 5 Years
Salvage Value is calculated using the formula given below:
Salvage Value = P (1 – D)n
- Salvage value = $8,00,000 (1 – 0.10 )5
- Salvage value = $8,00,000 – (0.90 )5
- Salvage value = $4,72,392
Depreciation and Salvage Value
Both depreciation and salvage value are correlated with each other. To calculate depreciation the salvage value of an asset is subtracted from its purchase cost. Depreciation is used as a measure of asset utilization over a period of time. With regard to income tax purposes, depreciation plays an important role in reducing taxable income and determining tax liability. There are several methods used by accountant to depreciate assets like the declining balance method, units of production method, and straight-line basis. Each of these methods uses various calculations to assign a value to an asset’s depreciation in an accounting year. The first step to calculate depreciation is to subtract the salvage value of assets from its acquisition cost. Salvage value is the scrap/ residual value for which the asset can be sold after the end of its useful life. For example, a travel company sell its inoperable bus for parts at a price of $10,000, then this is the salvage value of the bus. If the sam bus costs $1,00,000 at the time of purchase then the total amount of depreciated over its useful life is $90,000.
Uses and Importance of Salvage Value
- Salvage value is significant for any organization as it allows the companies to determine depreciation and thereby net income.
- With the depreciation deduction in income taxes, salvage value plays an important role in determining depreciation deduction value for income tax liability calculation.
- It plays a major role in making capital budgeting decisions as it represents a value that the company will accrue after the use of any asset.
- Miscalculation of salvage value results in under-reporting of depreciation that leads to higher profits than normal and vice versa.
- While determining return from an asset, it gets added in inflow items as salvage value is the price the company will earn at the end of useful asset life.
Salvage Value vs Book Value
Both salvage value and book value are different measures of value. Book value is the value at which an asset is recorded in an entity’s books of accounts which may be cost price in the initial year, depreciated written down value in the coming year, and may be equal to salvage value at the end of its useful life. Whereas salvage value is the estimated price the company will earn from the sale of an asset at the end of its useful life. Book value is the total estimated value that a shareholder in a company receives if it is sold or liquidated at any moment of time. It is a metric that helps investors and analysts to evaluate if the stock is overpriced or underpriced when compared to actual fair market value. Salvage value is used by management to calculate annual depreciation in the accounting records and to calculate depreciation expense on the tax return.
Conclusion
Salvage value is the estimated price an entity will realize from the disposal of an asset at the end of its useful life. Mainly used to calculate yearly depreciation charge on tangible which in turn affects net profits, taxable profits, etc. As its an amount that will be received after utilization, it is also known as scrap value or residual value.
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