What is Salvage Value (Scrap value)?
Salvage value or Scrap Value is the value of an asset after its useful life is over. For example, if the machinery of a company has a life of 5 years and at the end of 5 years, its value is only $5000, $5000 is called as salvage value.
When a company purchases an asset, first, it calculates the salvage value of the asset. Thereafter this value is deducted from the total cost of the assets and then the depreciation is charged on the remaining amount.
If it’s very difficult to calculate this value, the normal practice is to depreciate the asset on the total cost, considering its value as nil. There is one issue with this concept. Since this value is deducted before depreciation is charged, people can use it in a fraudulent way. They can deduct more salvage value and as a result, the amount of depreciation would be reduced. And that means the profit of the company will increase too.
Another name of this value is scrap value. And this is a mere estimate only. No-one knows what a piece of equipment or machinery would cost after 10 years. The piece of an asset may end up in a junkyard as well.
Salvage Value Example
Let’s take an example to understand this.
- Let’s say that Treat Inc. has purchased equipment at $100,000. The company finds out that the useful life of this equipment is 10 years and at the end of 10 years, the value of the equipment would be $10,000. So the scrap value of the equipment is $10,000.
- Now, as we know that the value of the equipment is $10,000, the depreciation for this equipment will be calculated on = ($100,000 – $10,000) = $90,000.
Salvage Value Formula
Let’s have a look at the salvage value formula below –
Here, P = Original cost of the asset, i = depreciation rate, y = number of years
So, to find out the scrap value, you first need to make sure that the depreciation rate should be determined. Along with that you also need to know how many years the asset will last (the useful life of the asset)
Salvage Value Formula Example
Kites Ltd. has bought an asset of $1 million. They figured that the useful life of the asset would be around 20 years. And the depreciation rate on which they will depreciate the asset would be 20%. Find out the salvage value of the asset Kites Ltd. just purchased.
In this example, we have been given the original price of the asset, i.e. $1 million. The useful life of the asset is also given, i.e. 20 years and the depreciation rate is also provided with, i.e. 20%.
Salvage value formula = P (1 – i) y = $1 million (1 – 0.20) 20 = $1 million (0.8) 20 = $11,529.22
What if the Salvage Value of any Asset is Zero?
What if the salvage value of an asset at the end of its useful life is zero? What should one do then?
- As per the US Income Tax Regulations, while depreciating an asset, you need to assume that the scrap value of the asset would be zero.
- If we assume that the salvage/scrap value is zero and if we find that at the end of the useful life, we can get a value, we can account it as a gain of the company instead of estimating it beforehand.
- As a result, there would be no estimation error in finding out the scrap value and no-one would be able to use this value as an excuse to encourage/support fraudulent practices.
How is Scrap value seen in Cost Accounting?
- In cost accounting, the idea of scrap value is slightly different than the concept in financial accounting.
- In cost accounting, the scrap value is the raw materials of the product that the manufacturer will sell off as scraps.
- That means it has nothing to do with the obsolescence of an asset. Rather it’s the raw materials that are of no value to the manufacturing company.
Why is Scrap Value not Reduced to the Present Value?
Scrap Value is a projected value of an asset that can’t be used any longer for original purposes. Or even if we can use the asset, there would be no efficiency.
- Let’s say that we buy a car for business at $100,000. And we project that the salvage value of the car after 15 years would be $10,000. Now this means two things –
- First, the used car can be sold at $10,000 after 15 years.
- Second, the used car can’t offer enough efficiency to keep it for business purpose.
- Now, if we discount the scrap value to its present value, it wouldn’t be the right estimation; because then at today’s date, the scrap value would be very less. Plus how would we find the right discounting rate?
That’s why it’s wiser to go for zero value while applying depreciation on the asset. If we imagine that this value would be nil, there would be no chance of any reduction in depreciation. And as a result, the profit of a company can’t be inflated.
Salvage Value Calculator
You can use the following Salvage Value Calculator.
|Salvage Value Formula =|| |
Salvage Value in Excel (with excel template)
Let us now do the same salvage value formula example above in Excel.
You can easily calculate the SV in the template provided.
You can download this salvage value template here – Salvage Value Excel Template
There is confusion between salvage value, scrap value, and residual value. However, scrap value and residual value are just other names of salvage value in accounting.
To summarize, it is the value of an asset after its useful is over. Scrap value is an estimated figure. It can be calculated if we can determine the depreciation rate and the useful life. In the US, for tax purposes, the depreciation is calculated by assuming the scrap value as zero.
Salvage Value Video
This has been a guide to what is salvage value (scrap value)? Here we discuss salvage value formula, its calculator along with excel examples and templates. You can also refer to the following articles to learn more about accounting –