Residual Value definition

The residual value or salvage value is the estimated amount that an entity expects to receive in the future for the sale of a property, plant, and equipment or an intangible after a certain period of use.

Residual value in property, plant and equipment

The residual value is calculated multiplied the total cost of an asset by an estimated percentage by the entity’s management.

 In other words, if a company acquires a building for 10 million and expects to sell it for one million after a time of use, this means that the salvage value is 10%.

Generally, the residual value of property, plant, and equipment is exclusive of the real states.

This is so because the assets with these characteristics tend to present valuations, while other types of assets, how the machines and the vehicles, tend to lose value.

This means that an asset, such as a building, will have some remaining value after a specific long time of use.

In change, it is very probable that a vehicle or a computer at the end of its useful life will have a value of null or almost null.

That is, a salvage value equal to zero.

Salvage value and depreciable amount

The depreciation of property, plant and equipment is the systematic distribution of the total cost of an asset throughout its useful life.

To determine this value first is necessary to establish the depreciable amount.

This is, the total cost of an asset once deduced the residual value.

For example, an entity acquires a building for 2 million, with a useful life of 50 years and a residual value of 10%,

In this case, the depreciation that must be recognized in profit or loss each year is 36,000.

Then, the depreciable amount is equal to 1,800,000 (2,000,0000 – 200,000)

Depreciation expense = 1,800,000 / 50 years = 36,000

If the depreciation charge is associated with property and equipment construction or inventory production, an entity should not recognize a depreciation expense in profit or loss.

In contrast, an entity must account for this depreciation as a higher value of a fixed asset or an inventory. 

The residual value and depreciation of an asset

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Paragraph 54 IAS 16 establishes that the residual value could increase so that it be equal to or higher than the asset cost; in this case, the depreciation charge would be zero.

However, if, subsequently, the entity reviews the salvage value again and determines that this value has decreased so that it is lower than the total cost asset, the entity must recognize the entity a depreciation charge again.

Salvage value changes and the accounting estimates.

Under paragraph 51 of IAS 16, an entity shall review whether the salvage value of the asset has changed at least once at the end of the reporting period.

It is important to consider that the residual value may change, since being an accounting estimate is subject to new information that may arise throughout the useful life of the asset.

For example, in year 1, an entity acquires a warehouse for 5 million, with a useful life of 30 years and a salvage value of 5%.

This means that the depreciable amount is 4,750,000, equivalent to 5 million less than 5% of the total cost asset.

Therefore, the company must recognize an annual depreciation of 158,333, equal to the depreciable amount divided over the useful life of the asset.

Now, what happens if, at the beginning of year 12, due to new information, the residual value goes from 5% to 9%?.

In this case, we must review IAS 8, accounting policies, changes in accounting estimates, and errors.

This standard establishes that changes in estimates should be recognized prospectively, and changes in accounting policies and errors must be recognized retroactively.

On the other hand, returning to our example, we find that the change in the salvage value change of 5% to 9%

This is a change in an estimate because its variation is the product of new information that has emerged.

Now , the new depreciable amount of the asset is 2,808,333 (3,258,333 – 450,000) which is equivalent to the asset’s carrying amount in year 12 minus 450,000 of salvage value (5,000,000 X 9%), 

That is, the new charge for depreciation for year 12 is 147,807 (2,808,333 / 19 years remaining useful life).

However, if the change in residual value had occurred due to new information that the company omitted, or rather, the result of an error, the entity should recognize the effect of this error from the beginning of the depreciation charge in previous periods.

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Residual value of intangible assets

As in IAS 16, IAS 38 also contemplates using the salvage value in intangible assets.

Paragraph 100 of this standard establishes that the salvage value will be zero unless one of the following conditions is met.

It is expected that there will be a commitment from a third party to purchase the asset at the end of its useful life. 

Or there is an active market

That is, the entity can measure the fair value of the intangible reliably.

The salvage value and amortization of intangibles

IAS 38 establishes that intangibles can be of two types: a finite useful life or an indefinite useful life.

Within assets with a finite useful life, we can find the following: patents, software, and licenses, among others.

These assets must be amortized over their useful life.

The management of a company must determine whether it is necessary to estimate the salvage value of this type of asset.

However, if we are talking about intangibles with an indefinite useful life, such as the acquired brands, there will not be the right to calculate the residual value since these assets are not amortized.

However, it will be necessary to review periodically if these have deteriorated.

Unlike acquired brands and other types of intangibles, paragraph 63 of IAS 38 establishes that brands, mastheads, publishing titles, customer lists, and similar items will not be recognized as intangible assets because they are internally generated.