Salvage Value

Salvage value is the estimated amount a company expects to recover from a fixed asset when it is retired at the end of its useful life, after deducting the costs of removing and selling it. It may come from selling the asset second-hand, trading it in, or selling it as scrap. Salvage value is also known as scrap value and, particularly under IFRS and in leasing, as residual value.

Salvage value matters because it determines how much of an asset's cost is charged as depreciation. Only the part of the cost that the business expects to use up, cost minus salvage value, is spread over the asset's life. This amount is called the depreciable cost. Salvage value is an estimate made when the asset is first placed in service and reviewed when circumstances change.

For straight-line depreciation, the annual charge is:

Here $\text{Cost}$ is everything paid to acquire the asset and make it ready for use, $\text{Salvage value}$ is the estimated net disposal amount and $\text{Useful life in years}$ is how long the business expects to use it. The units-of-production method uses the same depreciable cost, divided by expected total output.

The declining balance method and the double-declining balance method work differently: they apply a rate to the asset's carrying amount without first subtracting salvage value, but depreciation stops once the carrying amount reaches the salvage value. Under every method, an asset is never depreciated below its estimated salvage value.

A construction company buys an excavator for $250,000. It expects to use it for eight years and then sell it at auction for about $42,000, paying $2,000 in transport and auction fees. Salvage value is therefore $40,000. Straight-line depreciation is $250,000 minus $40,000, divided by 8, or $26,250 a year.

After eight years, accumulated depreciation is $210,000 and the book value is $40,000. If the excavator is sold for net proceeds of $46,000, the company records a $6,000 gain on sale of assets. If net proceeds are only $31,000, it records a $9,000 loss on sale of assets. If the estimate is revised during the asset's life, the change is treated as a change in accounting estimate and applied only to current and future depreciation.

• Market data: prices of similar used assets, auction results and dealer guides, adjusted for expected condition at retirement.
• Company history: what similar assets have fetched in past disposals.
• Disposal costs: removal, dismantling, transport and selling costs reduce salvage value; if they exceed the expected proceeds, salvage value is zero or negative, and asset retirement obligations may apply.
• Materiality: many businesses assume zero salvage value for computers, furniture and other low-value items, which simplifies record-keeping.

Overestimating salvage value reduces depreciation and inflates profit, so auditors check that estimates are reasonable, particularly for vehicles, aircraft and heavy equipment, where salvage values can be large.

For federal income tax, most tangible business property placed in service after 1986 is depreciated under the Modified Accelerated Cost Recovery System (MACRS), which ignores salvage value: the full cost basis is recovered over a set recovery period. Section 179 expensing and bonus depreciation also disregard it. Book depreciation for financial statements, which does use salvage value, therefore usually differs from tax depreciation, creating temporary differences and deferred income taxes.

• Internal Revenue Service