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Salvage Value

Understand the Concept of Salvage Value

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Salvage Value

How to Calculate the Salvage Value

The salvage value is considered the resale price of an asset at the end of its useful life.

In order words, the salvage value is the remaining value of a fixed asset at the end of its useful life.

Under accrual accounting, the cost of purchasing PP&E like machinery and equipment – i.e. capital expenditures (CapEx) – is expensed on the income statement and spread out across the useful life assumption.

The useful life assumption estimates the number of years an asset is expected to remain productive and generate revenue.

The carrying value of the asset is then reduced by depreciation each year during the useful life assumption.

Salvage Value Formula

Calculating the residual value of the fixed asset is a two-step process:

  1. The annual depreciation is multiplied by the number of years the asset was depreciated, resulting in total depreciation.
  2. The original purchase price is subtracted from the total depreciation expensed across the useful life.
Formula
  • Salvage Value = Purchase Price – (Annual Depreciation × Number of Years)

How the Salvage Value Impacts Depreciation Expense

The calculate the annual depreciation expense, three inputs are necessary:

  1. Purchase Price of Asset
  2. Salvage (Residual) Value
  3. Useful Life Assumption

The difference between the asset purchase price and the salvage (residual) value is the total depreciable amount.

To calculate the annual depreciation expense, the depreciable cost (i.e. the asset’s purchase price minus the residual value assumption) is divided by the useful life assumption.

Formula
  • Annual Depreciation = (Purchase Price of Asset – Salvage Value) / Useful Life

If the residual value assumption is set as zero, then the depreciation expense each year will be higher, and the tax benefits from depreciation will be fully maximized.

The impact of the salvage (residual) value assumption on the annual depreciation of the asset is as follows.

  • Higher Salvage (Residual) Value → Lower Annual Depreciation
  • Lower Salvage (Residual) Value → Higher Annual Depreciation
Straight-Line Depreciation

Under straight-line depreciation, the asset’s value is reduced in equal increments per year until reaching a residual value of zero by the end of its useful life.

The majority of companies assume the residual value of an asset at the end of its useful life is zero, which maximizes the depreciation expense (and tax benefits).

Salvage Value Calculator – Excel Template

We’ll now move to a modeling exercise, which you can access by filling out the form below.

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PP&E Salvage Value Calculation Example

For our example scenario, we’ll assume a company spent $1 million purchasing machinery and tools. The fixed assets are expected to be useful for five years and then be sold for $200k.

Given the information above, the model assumptions are as follows.

  • PP&E Purchase Price = $1 million
  • Useful Life Assumption = 5 Years
  • Salvage Value = $200k

Next, the annual depreciation can be calculated by subtracting the residual value from the PP&E purchase price and dividing that amount by the useful life assumption.

  • Annual Depreciation = ($1 million – $200k) / 5 Years = $160k

While the purpose of this exercise is to see how our salvage (residual) value assumption impacts the annual depreciation expense, which in turn impacts the PP&E balance – we can also calculate the residual asset value using the formula discussed earlier.

  • Salvage Value = $1 million – ($160k × 5 Years) = $200k

The beginning balance of the PP&E is $1 million in Year 1, which is subsequently reduced by $160k each period until the end of Year 5.

By the end of the PP&E’s useful life, the ending balance should be equal to our $200k assumption – which our PP&E schedule below confirms.

Salvage Value

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