Here’s What Tax Salvage Value Is With Examples

A business that utilizes tangible assets may eventually have to deal with the costs linked with their respective properties. If there is an expected benefit that you can derive from an asset in the future, some costs are better off delayed rather than handled as a current expense. When it comes to financial reporting, the business will then record the depreciation cost for the year. Throughout this process, four important criteria are involved: the cost of the asset, its useful life, a depreciation method, and its salvage use.

In this article, we will discuss all you need to know about tax salvage value and its significance, along with informative examples along the way.

What is Salvage Value?

Salvage value refers to the estimated value or price of an asset after it has entirely expensed its depreciation. It can also define as the amount that a particular asset is estimated to be worth once its useful life ends. Usually, the end of its useful life occurs beyond a year. In other words, it is also the non-current or resale value that a company generally expects in return for sharing or selling the asset within a competitive market where there is a free exchange of goods.

You can determine the estimated salvage value for any type of asset that a company ought to be depreciating on its records as time goes by. Every company tends to have its own standards for estimating an asset’s salvage value. For instance, firms may opt to continually depreciate a certain asset to $0, especially when the salvage value is only very minimal.

Generally, the tax salvage value is vital since it will be the existing value of a specific asset recorded on the books of the company once it has passed depreciation. It is largely based on the worth that a company expects to get from its sale at its useful life’s end. However, in some cases, a tax salvage value may only pertain to a value that a business believes or thinks it can acquire by selling an inoperable or depreciated asset for various parts.

Before-Tax and After-Tax Salvage Value

Now that you know the general definition of salvage values, here are the other concepts involving it. These include the Before-Tax Salvage Value and the After-Tax Salvage Value.

Before-Tax Salvage value refers to the selling price of a certain good once it’s sold off. On the other hand, the After-Tax Salvage Value pertains to the value at which the sold-off good becomes an income, therefore attracting tax. After deducting the required tax, the value you’re left with is the after-tax salvage value.

Assumptions about Salvage Value and Depreciation

When drawing certain assumptions for salvage value and depreciation, companies usually consider an appropriate set of principles for this. The matching principle utilized in this matter is called the accrual accounting’ concept, which mandates a company or business to recognize expenses simultaneously as when similar revenues are obtained. If a company forecasts that a particular asset will be useful in contributing to revenue for an extended period, then it will have a longer and equally useful life.

On the other hand, if a company is uncertain about a particular asset’s useful life and significance, then there will be an approximately lower number of years as estimated. At the same time, this also means a greater salvage value to support the asset on the books after depreciation or sell the asset at its respective salvage value. If a firm opts to front-load its depreciation expenses, it can adapt an accelerated depreciation method that instantly deducts a bigger amount of depreciation expenses. A lot of companies usually prefer using the $0 salvage value since they believe that the utilization of an asset has completely matched the recognition of its expense with the revenues throughout its useful life.

Calculating Salvage Value

Here are the steps you need to follow to calculate an asset’s salvage value accurately.

Determine the machine’s actual cost. The actual cost usually refers to the asset’s purchase price alongside installation and other significant and incurred expenses for making the asset useful.

Determine the applicable rate of depreciation per asset category as stated in the standard guidelines for accounting. The depreciation rate refers to how the asset will be written in the accounting books.

Determine the asset’s useful life for where it will provide prospective economic benefits to the company.

Apply the appropriate formula for salvage value which is: P (1-D)n

Some Examples of Salvage Value

Suppose that XYZ company purchases an asset amounting up to $100,000. The company estimates that the asset’s salvage value will amount to $10,000 in the next five years once it plans to discard the asset. This means that the company will choose to depreciate approximately $90,000 of the said asset cost for five years, leaving the amount of $10,000 of the cost remaining at the end of this period. XYZ company then expects to put the asset up for sale, thereby eliminating the asset from the company’s accounting records.

Here is another example. Let’s say that Unilever has bought a vehicle that costs $1,000,000 with a 10-year useful life and an applicable depreciation of about $80,000 every year. To calculate the salvage value, use the formula mentioned above, where you multiply the cost of the asset by the product of (1 subtracted by the amount of depreciation) raised to 10 years.

It will look something like this: Salvage value = $1,000,000 – ($80,000 x 10). The result is $200,000.

Depreciation Methods

Salvage value and depreciation are terms that are highly associated with each other. The depreciation of an asset’s salvage value is calculated by subtracting it from its cost of purchase. Depreciation is often utilized as a tool for measuring asset utilization over a certain period. Regarding purposes involving income tax, depreciation is also important in determining tax liability and decreasing taxable income.

Financial accountants often use five primary depreciation methods to create depreciation schedules. These are the sum-of-years digits, straight-line, units of production, double-declining balance, and declining balance.

Each method needs a sufficient amount of consideration when dealing with salvage value. The total accumulated depreciation refers to the asset’s depreciable amount once all the depreciation expenses have been put down on the books. Consequently, this is also the result of deducting salvage value from historical cost. An asset’s carrying value while undergoing depreciation is already its historical cost minus its current accumulated depreciation.