Understand residual value as well as finding out how it is defined, calculated and why it matters in accounting.
Table of contents
1. What is Residual Value?
Residual value is the estimated value of a fixed asset at the end of its useful economic life. Say, for example, a business purchases equipment for £10,000 which it estimates will be in use for 10 years at which point the scrap value will be £4,000 – the residual value in accounting will be £4,000.
2. How to Calculate Residual Value
Residual value, to some extent, is subjective because it requires making an estimate of how much something is worth in the future. There are no set rules to follow when it comes to determining residual value. To calculate the residual value of an asset you should consider:
- The type of asset assessed
- The residual values of similar assets in the current market
- How the business intends to use the asset (heavy use may indicate a lower scrap value)
- The investment the business intends to spend to maintain the asset over the years it is using it (better maintenance may improve scrap value)
3. Why Does Residual Value Matter in Accounting
Residual value affects depreciation calculations in accounting. Depreciation calculations are based on the cost of the asset minus residual value. So using the example above, if the business uses straight-line depreciation over 3 years on its equipment depreciation will be calculated on £6,000 (£10,000 – £4,000).
- What is an Asset in Accounting?
- What is the Useful Life of a Fixed Asset and How to Calculate It
- How to Calculate UK Depreciation and Depreciation Rates
- What is a Balance Sheet?
Friendly Disclaimer: Whilst I am an accountant, I’m not your accountant. The information in this article is legally correct but it is for guidance and information purposes only. Everyone’s situation is different and unique so you’ll need to use your own best judgement when applying the advice that I give to your situation. If you are unsure or have a question be sure to contact a qualified professional because mistakes can result in penalties.