Salvage ValueEven if fully depreciated, an asset can still have value

Long-term assets will eventually deteriorate and become unusable.

When a long-term asset is in its last days, it’ll probably lose most if not all of its value.

When that time comes, you’d have to dispose of it in whatever way you can.

Having practically worthless assets occupy your business’s place of operations isn’t being efficient, is it?

They take up space but don’t provide you any kind of benefits in return.

Better replace them with ones that you can use, right?

Thankfully, for most assets, you can still recover some of your investment no matter how minimal the amount is.

Something is better than nothing after all.

For example, a piece of equipment has already reached the end of its useful life.

It’s no longer usable and as such, should be let go.

The business that owns it can sell it for scraps.

Or they can find a market that buys fully depreciated assets for more than just scrap value.

Whichever of the two scenarios occurs, the business still gets something back from its investment (the acquisition price of the piece of equipment).

We refer to this amount as the asset’s salvage value.

That said, an asset’s salvage value is more than just the amount you can receive when you dispose of the asset.

It is an important component in the computation of an asset’s depreciation.

In this article, we will learn about salvage value.

We will learn its definition, as well its role in the computation of an asset’s depreciation.

We will also learn about the methods to determine an asset’s salvage value.

What is Salvage Value?

Salvage value refers to the monetary value that a business can obtain when it sells a fully-depreciated asset.

Or you could also see it as the asset’s value at the end of its useful life.

The amount is dependent on several factors such as the asset’s age, condition, rarity, market demand, wear and tear, obsolescence, etc.

For example, imagine buying a brand new car for $40,000.

After using it for about five years and accumulating a mileage of 100,000 miles, you would think that the car is fully used or exhausted.

Given that information, what do you think is the value of the “fully used” car?

Is it still the $40,000 that you paid for it?

Of course not. No one would buy it for that amount.

Rather, the value of the car depends on how much you can sell it for.

It could be for scraps, or it could be that someone is still willing to purchase it as is.

And whatever is the amount that you can expect to receive from the sale of the “fully used” car is its salvage value.

Salvage value is one of the components in the computation of an asset’s depreciation, the other two being the asset’s acquisition cost and its estimated useful life.

The difference between the asset’s acquisition cost and salvage value is its depreciable amount.

This depreciable amount will be recorded as an expense, spread over its estimated useful life.

Salvage value puts a cap on the amount that you can recognize as depreciation expense for an asset.

As such, you want to be as accurate in its estimation as possible.

Overestimating salvage value will understate depreciation.

In contrast, underestimating salvage value will overstate depreciation.

Do note though that for tax depreciation under MACRS, salvage value is generally a non-factor.

Why is Salvage Value Important?

As already mentioned, salvage value is one of the components in the calculation of an asset’s depreciation.

It determines the amount that you can recognize as depreciation expense.

Overestimating or underestimating an asset’s salvage value can cause an understatement or overstatement in the business’s net income.

For example, let’s say that you acquire a long-term asset for $15,000.

You expect that you can sell it for $1,000 at the end of its useful life.

That means that if you were to use such an amount for the asset’s salvage value, that means that its depreciable amount is $14,000.

But what if the asset only has a salvage value of $500 in actuality?

This means that you overestimated the asset’s salvage value by $500.

This leads to an understatement of depreciation expense of $500.

And this ultimately leads to an overstatement of net income of $500.

That’s why it’s important to be as accurate with your estimation as possible.

Each business has its own guidelines for determining or estimating an asset’s salvage value.

Some businesses may even choose to always set their assets’ salvage value as zero.

This is the most conservative approach as it means that the business will be recognizing the full acquisition cost of the asset as a depreciation expense over its useful life.

Whatever the case is, it’s prominent that salvage value is important in the computation of depreciation.

Making a Reasonable Estimate of an Asset’s Salvage Value

An asset’s salvage value is an estimate.

It’s not an absolute statement about an asset’s future value.

As such, it will most probably be not 100% accurate all the time.

But being accurate and reasonable are two different things.

You want to make a reasonable estimate of an asset’s salvage value.

And to do so, here are some key questions you might want to address when making an estimate:

• What will happen to the concerned asset after it is fully depreciated? Will the business keep it within its premises? Does the business plan to refurbish the asset? Will the business retire it? Or will the business sell or dispose of it externally?
• What will be the condition of the asset at the end of its useful life? This is largely dependent on how the asset will be used. Some assets may be in good enough condition, while some assets will have to be butchered for scraps.
• Depending on the answers to the previous questions (How will the business dispose of the asset? What will be the asset’s condition?), will the business be receiving any proceeds? If yes, what amount does the business expect to receive?

You can add more guide questions, but these three key questions should suffice to make a reasonable estimate of an asset’s salvage value.

Methods to Determining Salvage Value

Aside from the key questions above, you can also use one of the following three approaches:

The Cost Approach

The cost approach uses the material and labor costs that the business will incur to repair an asset in the estimation of an asset’s salvage value.

This approach is more useful for assets that the business intends to retain even if they’re at the end of their respective useful lives.

The Market Approach

The market approach uses the price that a buyer is willing to pay for the fully depreciated asset in the estimation of an asset’s salvage value

. This approach is useful for assets that the business intends to dispose of externally, usually through the sale of assets.

The Replacement Cost Approach

The replacement cost approach uses the estimated cost to replace a fully depreciated asset with a new one.

This approach is useful for assets that the business usually replaces when they reach the end of their useful lives.

In some cases, whatever the approach, an asset will have no salvage value.

That’s not necessarily bad news though.

It only means that the asset has zero value once it is fully used, consumed, or exhausted.

In the computation of such assets’ depreciation, the full cost of the assets will be eventually recognized as a depreciation expense.

A Foundation For a Reasonable Estimate of Salvage Value

Some assets will naturally have no salvage value.

Or if there is, the amount is very minimal if we compare it to the costs of acquiring the asset.

This is usually the case for short-lived (2 to 4 years), low-cost assets such as computers or phones.

These assets are usually disposable and highly replaceable.

Higher value and long-lived assets are a different story though.

These assets usually have significant salvage values due to their high cost of acquisition.

Imagine a $1,000,000 asset with a useful life of 10 years.

Even after 10 years, the asset will still have significant value.

To make a reasonable estimate of salvage value, you need a good foundation.

And one way to build such a foundation is to look for available data.

Make sure that they’re facts that you can work with. Some sources of data are the following:

• Previous history and experience with a similar asset;
• How much is the asset selling for today compared to its original cost? You can then apply the percentage to determine the salvage value
• You can have the asset appraised. Though this is only practical for high-value assets due to the usually high cost of an appraisal.
• You can take a look at how equipment leasing and asset-based lending businesses value their assets. These businesses usually have a good grasp of their assets’ residual values

Aside from the sources of data above, you should also consider any restrictions that can limit your ability to dispose of the asset.

For example, a government might mandate specific disposal procedures for certain kinds of assets.

This limits your methods of disposal for such assets and can even set their salvage value to zero.