In the accounting field, the residual value is the value of a property , plant at the end of its useful life after deducting the expenses for amortization and depreciation . From another point of view, the residual value is the amount that the company expects to obtain by selling the fixed assets when its useful life ends.
When we buy a fixed asset such as a vehicle, we hope that when its useful life ends (15 years for example), we can sell it for a certain amount. This amount is the residual value.
The residual value is also known by other names as recoverable value or salvage value.
Factors to consider when calculating the residual value
There are a number of factors that need to be analyzed to understand the definition of residual value:
- Firstly, the residual value is only calculated on fixed assets. That is, on buildings, machinery, transport elements, etc. No residual value is calculated on other equity elements (other assets , such as inventories, or liabilities )
- Initial value of fixed assets. We start from this value, which will be the acquisition value or the manufacturing cost.
- Of the value of fixed assets are deducted the costsof amortization and depreciation . These expenses are attributed to the fixed assets by use or by the passage of time. The amortization is calculated during the years of useful life of fixed assets; once the useful life has expired, no amortization or depreciation expenses are charged.
For example, if a fixed asset has a useful life of 10 years, it will be amortized during those 10 years. In year 10 the residual value can be obtained by the following calculation:
Residual value = Value of fixed assets – Amortization / depreciation expenses
Example calculation of residual value
Let’s imagine the following example: a company acquires machinery for 100 monetary units. This machinery has a useful life of 4 years, during which it pays 20 monetary units each year. What is the residual value of the machinery?
Firstly, the residual value can be obtained because the machinery is a fixed asset. The acquisition value is 100 monetary units, while the accumulated amortization during the 4 years is 80 monetary units (20 monetary units each year). Therefore, the residual value is 20 monetary units (100-80).
Implications of residual value in the calculation of depreciation
Sometimes the residual value is an amount estimated by the legislator or the company itself. For example, it can be established that the residual value of a machine is 5% of its acquisition value. This has a series of implications in the calculation of annual amortization, which we will see with the following example:
A company purchases a car that has an acquisition value of 100 currency units, the residual value of which is 20% of the acquisition value. The useful life is 4 years and linear amortization is practiced. What is the annual depreciation of the car?
The residual value is 20 monetary units. To calculate amortization, this residual value must be reduced from the acquisition value: that is, 80 monetary units (100-20). On this value we divide the years of useful life and obtain an annual amortization of 20 monetary units (80/4 years).