If your client’s businesses have any fixed assets, determining the salvage value of those assets is important later when calculating depreciation. Though there is no precise formula for calculating an asset’s salvage value, two methods are commonly used in practice.
An asset’s salvage value is the estimated amount the fixed asset can be sold for once its useful life is finished. This value affects the amount of depreciation reported each year during the asset’s life. The higher the salvage value of the asset, the less depreciation is deducted each year, which results in higher profits. Estimating too high of a salvage value can be deemed a fraudulent accounting practice since profits are then artificially inflated. Because of this, it’s always safer to estimate a more conservative salvage value.
Two approaches are used to determine the dollar amount of salvage value. The first estimates the amount of years an asset can be used and then looks at the marketplace to see the sales price of similar assets of the same age. If multiple values are found, an average can be taken. The more commonly used approach is to simply estimate the salvage value to be zero. This is safer and more conservative in accounting practices so potential auditing issues don’t arise in the future.
As an example, assume a piece of equipment costs $200,000 and has an estimated useful lifespan of five years. You can research various equipment sellers to find a duplicate piece of equipment that’s five years old and see what it’s selling for at that point. Assume you find four examples of this piece of equipment that are selling for $30,000, $35,000, $18,000, and $20,000. It’s a safe assumption to average these values and determine that your client’s salvage value for that piece of equipment is: ($30,000 + $35,000 + $18,000 + $20,000) / 4 = $25,750. Of course, the safer assumption is to assume $0 for the salvage value.
Salvage value directly determines the amount of depreciation reported on the asset, which affects the company’s profits. You should do the required amount of research to arrive at a reasonable salvage value for the assets, and if no data exists, simply assume $0.