Salvage Value

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What is a Salvage Value (Scrap value)?

Salvage value or Scrap Value is the estimated value of an asset after its useful life is over and, therefore, cannot be used for its original purpose. 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, then $5000 is the salvage value.

Another name for this value is scrap value. And this is a mere estimate only. After ten years, no one knows what a piece of equipment or machinery would cost. The piece of an asset may end up in a junkyard as well.

What is a Salvage Value (Scrap value)?

Salvage Value Example

Let’s take an example to understand this.

Let’s say that Treat Inc. has purchased equipment for $100,000. The company found out that the useful life of this equipment is ten 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

Salvage Value (S) = P (1 - i)^y

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)

When a company purchases an asset, first, it calculates the salvage value of the asset. After that, this value is deducted from the total cost of the assets, and then the depreciation is charged on the remaining amount.

Example

Kites Ltd. has bought an asset of $1 million. They figured that the asset's useful life 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.

We have been given the asset's original price in this example, i.e., $1 million. The asset's useful life is also given, i.e., 20 years, and the depreciation rate is also provided, 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 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 scrap value is zero and find that we can get a value at the end of the useful life, we can account for it again for 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.
The scrap value is the product's raw materials that the manufacturer will sell off as scraps in cost accounting.
That means it has nothing to do with the obsolescence of an asset. Rather it's the raw materials of no value to the manufacturing company.

If you want to learn Cost Accounting professionally, you may want to look at 14+ video hours of Course on Cost Accounting.

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, a 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 purposes.
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 discounted rate?

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. That's why it's wiser to go for zero value while applying depreciation on the asset.

Salvage Value Calculator

You can use the following Calculator.

Salvage Value in Excel (with excel template)

Let us now do the same example above in Excel.

This is very simple. You need to provide the three inputs: the original cost of the asset, the depreciation rate, and the number of years.

You can easily calculate the SV in the template provided.

You can download this template here – Salvage Value Excel Template.

Conclusion

There is confusion between salvage value, scrap value, and residual value. In accounting, they all are the same.

The scrap value is an estimated figure. To summarize, it is the value of an asset after its usefulness is over. It can be calculated if we can determine the depreciation rate and the useful life. For tax purposes, the depreciation is calculated in the US by assuming the scrap value as zero.