Uncover the comprehensive guide to understanding the concept of Residual Value in asset management, including its role in calculating depreciation, its significance in tangible and intangible assets, and how changes can impact accounting estimates.
The concept of residual value, also referred to as salvage value, is defined as the estimated worth that an entity anticipates to attain from selling an asset like property, plant, equipment, or an intangible item following a designated period of use.
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In-depth Look at Residual Value in Assets such as Property, Plant, and Equipment
Residual value is a crucial component in asset management.
The calculation is done by multiplying the total cost of an asset by a percentage estimated by the organization’s management.
For instance, if a business purchases a building for 10 million and expects to sell it for one million after some time, the residual value is estimated at 10%.
This principle is mostly applicable to real estate properties as such assets often appreciate in value, contrary to other assets like machinery and vehicles that depreciate over time.
Therefore, while a building might still hold significant residual value after extended use, a vehicle or computer might end up having negligible or zero residual value.
Residual Value, Depreciable Amount, and Asset Depreciation
The depreciation of assets like property, plant, and equipment is essentially the systematic allocation of an asset’s total cost over its useful life.
Determining this value requires the calculation of the depreciable amount, which is the total cost of an asset less its residual value.
For instance, if a building costs 2 million, has a useful life of 50 years, and a residual value of 10%, the annual depreciation to be recognized is 36,000.
Hence, the depreciable amount equals 1,800,000 (2,000,000 – 200,000).
Considerations of Residual Value in Asset Depreciation
According to Paragraph 54 IAS 16, the residual value of an asset can increase to a point where it equals or surpasses the asset’s cost.
In such cases, the depreciation charge would be zero.
However, if the residual value decreases and becomes lower than the total cost of the asset, the entity must recognize a depreciation charge again.
Residual Value Changes and Accounting Estimates
Accounting standards require an entity to review changes in an asset’s residual value at the end of the reporting period.
Since the residual value is an accounting estimate, it is subject to modification based on new information that might emerge throughout the asset’s useful life.
Application of Residual Value in Intangible Assets
The application of residual value also extends to intangible assets as stipulated in IAS 38.
However, the residual value of intangible assets will only be above zero if there is a commitment from a third party to purchase the asset at the end of its useful life, or if there is an active market where the fair value of the intangible asset can be measured reliably.
The Role of Residual Value in the Amortization of Intangibles
IAS 38 categorizes intangible assets into two types: those with a finite useful life (e.g., patents, software, licenses, etc.) and those with an indefinite useful life (e.g., acquired brands).
The former are amortized over their useful life, and the management must decide if it’s necessary to estimate their residual value.
However, assets with an indefinite useful life are not amortized, though their condition must be periodically reviewed for any impairment.
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