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Salvage Value

What is a 'Salvage Value'

Salvage value is the estimated value that the owner is paid when the item is sold at the end of its useful life. The value is used to determine annual depreciation in the accounting records, and salvage value is used to calculate depreciation expense on the tax return. The value is based on an estimate of the asset's value, or the value can be determined by a regulatory body, such as the U.S. Internal Revenue Service (IRS).

Explaining 'Salvage Value'

The salvage value is used in conjunction with the purchase price and a specific accounting method to determine the amount of annual depreciation on the asset. A business owner can choose the straight-line depreciation method, which means that an equal amount of depreciation is recognized each year. If, instead, the owner chooses an accelerated method of depreciation, the company recognizes more depreciation in the early years and less in the later years of the asset's useful life.

How Straight-Line Depreciation Works

Assume, for example, that a company buys a machine at a cost of $5,000, and that the machine has a salvage value of $1,000 and a useful life of five years. Based on these assumptions, the annual depreciation using the straight-line method is: ($5,000 cost - $1,000 salvage value) / 5 years, or $800 per year. The asset's depreciable base is the cost less salvage value, or $4,000. Salvage value is subtracted from the cost of the asset in the depreciation calculation, because the owner sells the asset once the depreciated value declines to the salvage value.

Factoring in Accelerated Deprecation Methods

Accelerated depreciation means that the asset's depreciation is greater in the early years of the useful life and a smaller amount in later years. One popular method is the double-declining balance (DDB) method, which uses a depreciation rate that is twice is straight-line percentage. In the machine example, the rate of annual depreciation is ($800 annual depreciation / $4,000 depreciable base), or 20%. The DDB method calculates the first year of depreciation on the machine as ($5,000 machine cost X 40%), of $2,000. Because DDB uses a rate that is twice as large as the straight-line rate, more depreciation is recognized in the early years of the asset's useful life.


Further Reading


The case for using options to evaluate salvage values in financial leases
www.jstor.org [PDF]
… We show that the uncertain salvage value problem can be reduced to the evaluation of an option combination of a put and call … values, followed by a discussion of the issues involved in developing a model to value such options in Sec- tion IV. I. The Institutional Setting …

Financial policy and reputation for product qualityFinancial policy and reputation for product quality
academic.oup.com [PDF]
… We show that the uncertain salvage value problem can be reduced to the evaluation of an option combination of a put and call … values, followed by a discussion of the issues involved in developing a model to value such options in Sec- tion IV. I. The Institutional Setting …

An optimal replenishment policy for decaying items with shortages and salvage valueAn optimal replenishment policy for decaying items with shortages and salvage value
www.tandfonline.com [PDF]
… We show that the uncertain salvage value problem can be reduced to the evaluation of an option combination of a put and call … values, followed by a discussion of the issues involved in developing a model to value such options in Sec- tion IV. I. The Institutional Setting …

Replacement decisions with multiple stochastic values and depreciationReplacement decisions with multiple stochastic values and depreciation
www.sciencedirect.com [PDF]
… We show that the uncertain salvage value problem can be reduced to the evaluation of an option combination of a put and call … values, followed by a discussion of the issues involved in developing a model to value such options in Sec- tion IV. I. The Institutional Setting …

Strategic parameters for capital budgeting when abandonment value is stochasticStrategic parameters for capital budgeting when abandonment value is stochastic
www.tandfonline.com [PDF]
… We show that the uncertain salvage value problem can be reduced to the evaluation of an option combination of a put and call … values, followed by a discussion of the issues involved in developing a model to value such options in Sec- tion IV. I. The Institutional Setting …

Principal‐agent problems in S&L salvagePrincipal‐agent problems in S&L salvage
onlinelibrary.wiley.com [PDF]
… We show that the uncertain salvage value problem can be reduced to the evaluation of an option combination of a put and call … values, followed by a discussion of the issues involved in developing a model to value such options in Sec- tion IV. I. The Institutional Setting …

Abandonment value and project lifeAbandonment value and project life
books.google.com [PDF]
… We show that the uncertain salvage value problem can be reduced to the evaluation of an option combination of a put and call … values, followed by a discussion of the issues involved in developing a model to value such options in Sec- tion IV. I. The Institutional Setting …

Real options and interactions with financial flexibilityReal options and interactions with financial flexibility
www.jstor.org [PDF]
… We show that the uncertain salvage value problem can be reduced to the evaluation of an option combination of a put and call … values, followed by a discussion of the issues involved in developing a model to value such options in Sec- tion IV. I. The Institutional Setting …



Q&A About Salvage Value


How do you compute depreciation?

There are several standard methods for computing depreciation including straight line method and declining balance method (double declining balance method). These may vary by country and entity type. For tax purposes there may also be different rules on how much can be deducted from profits each year depending on what country you live in.

What is salvage value used for?

Salvage value is used to calculate depreciation expense on the tax return.

How does depreciation affect a business' balance sheet?

The decrease in value affects a business's balance sheet. In addition, accounting-wise, how one depreciates an asset affects net income and thus an income statement that businesses report. Generally, costs are allocated as expense among periods in which assets are expected to be used.

What are some ways to calculate annual depreciation?

One way is using straight-line method. Another way is using accelerated depreciation methods like double-declining balance (DDB) method.

What does depreciation refer to?

Depreciation refers to decreasing values over time or allocation methods for tangible assets like equipment or buildings.

How does one determine salvage value?

Salvage value can be determined by a regulatory body such as the Internal Revenue Service (IRS).

How do you calculate annual depreciation with DDB method?

The first year of depreciation on an asset using DDB method calculates as follows, where X = twice as large as straight line rate and Y = depreciable base or cost less salvage value.

What does DDB mean in accounting terms?

Double-declining balance means that the asset's depreciation is greater in the early years of its useful life and a smaller amount in later years.

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