Salvage Value Overview: How Does Salvage Value Work?

Salvage value is the monetary value of an asset that a business can expense at the end of its useful life. When a company purchases an asset for business purposes, it accounts for a sequential amount of depreciation (or decrease in value from its book value, or initial cost) for each year of use until it no longer serves its purpose.

Also known as scrap value, an asset's salvage value often represents the amount of money that a business hopes to sell it for once it fully depreciates. The residual value at the end of its useful life can also equal its sale for parts if the asset is no longer of any use.

Estimating an asset's salvage value helps a business determine its depreciation schedule. Identifying this schedule serves various important bookkeeping purposes for financial accounting departments, such as claiming tax deductions and estimating how much an asset will contribute to or subtract from cash flow.

Salvage value is important for many reasons. First, businesses can use it to determine write-offs for tax purposes. Accountants can deduct an asset’s yearly depreciation expense from the company’s taxable income. The depreciation expense is the amount of money an asset will lose in value over its useful life for the company.

Salvage value also helps a business determine an asset’s present value (which impacts its final resale value) at any point in its depreciation schedule. If a business expects an asset to bring in revenue over an extended period of time, they consider it a fixed asset with a long useful life, and salvage value may not apply.

Estimating an asset's salvage value determines exactly how much it depreciates—or loses value—across its useful life. The business charts each year of the asset’s depreciation as a business expense until it can sell or scrap it (sell for parts) at the end of its useful life. If a business plans to use an asset for a long time, its depreciation will be slower. For short-term use, the depreciation schedule will be faster. Here are the bookkeeping methods accountants use for calculating depreciation:

1. 1. Straight-line depreciation: The straight-line depreciation method is the most standard depreciation calculation that accountants use. This method allows businesses to calculate an asset’s standard yearly depreciation percentage by subtracting its desired salvage value from its initial cost. Bookkeepers then divide that number by the asset's useful life (in a number of years) to calculate the yearly depreciation percentage applied to the initial value. For example, if the initial cost of the asset is $5,000 and the business determines that it will have a useful life of ten years with an estimated salvage value of $500, the accumulated depreciation or total loss in value is $4,500 over ten years, which is $450 per year, or ten percent per year.
2. 2. Declining balance depreciation: The declining balance method accelerates an asset’s loss in value. The idea behind this method is to apply the yearly depreciation percentage to the decreased value of the asset with each coming year. For example, if a company buys an asset for $5,000 and determines that it will have a useful life of ten years with a scrap value of $500, the first year of depreciation is $450, or ten percent. The following year, the depreciable amount is ten percent of the remaining value ($4,500 - $450), or $4,050, and so on for each year in the depreciation schedule.
3. 3. Double-declining balance depreciation: The double-declining balance method (or DDB) accelerates an asset’s depreciation even more than the straight-line depreciation and declining balance methods. This strategy doubles the annual depreciation percentage each year, determined by the predicted salvage value and the depreciation schedule. With this method, accountants double the depreciation percentage calculated with the straight-line method, then apply that percentage to the asset’s declined value each year. For example, the yearly depreciation percentage would double from ten to twenty percent. Therefore, the first year's depreciation would be twenty percent of $4,500, or $900. The following year would be twenty percent of the remaining $3,600, or $720.
4. 4. Sum-of-years digits: This method relies on a fraction determined by the total number of years in the depreciation schedule. Accountants use the asset's useful lifespan to determine the common denominator, which they divide into each year. They multiply that number by the difference between the asset’s initial value and salvage value. For example, if the asset’s useful life is ten years, accountants calculate the common denominator for the fraction by adding 10+9+8+7+6+5+4+3+2+1 = 55. The fraction for each year is the total number of years left over the common denominator (the first year would be 10/55, the following year 9/55, etc.). Each year, accountants multiply the fraction by the total depreciation value, the difference between the asset’s initial value and its salvage value.
5. 5. Units of production: This method uses an estimate of the number of units an asset is predicted to produce in one year. Accounts use the estimated number of units to calculate each year's depreciation expenses in the schedule.

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