how to calculate residual value
there are two components to calculating residual value estimated salvage value and the cost of asset disposal the net proceeds received by the disposition less the cost of disposal is the residual value residual value salvage value cost of asset disposalbe mindful that for assets with a low salvage value and high cost to dispose of it is entirely possible to have a negative residual value this means it will result in a liability for a company to be rid of the asset at the end of its useful life a strong example is assets that must adhere to regulatory disposal requirements to remove waste without environmental contamination the difficulty in calculating residual value lies in the fact that both the salvage value and the cost to dispose of the asset may not truly be known until disposition management must make an estimate on both and companies often rely heavily on comparable assets or transactions that have happened in the past to better understand the financial implications of their own item s management must periodically reevaluate the estimated value of the asset as asset deterioration obsolescence or changes in market preference may reduce the salvage value in addition the cost to dispose of the asset may become more expensive over time due to government regulation or inflation though residual value is an important part in preparing a company s financial statements residual value is often not directly shown on the reports uses of residual valueif you lease a car for three years its residual value is how much it is worth after three years the residual value is determined by the bank that issues the lease and it is based on past models and future predictions along with interest rate and tax the residual value is an important factor in determining the car s monthly lease payments additionally consider the example of a business owner whose desk has a useful life of seven years how much the desk is worth at the end of seven years its fair market value as determined by agreement or appraisal is its residual value also known as salvage value this information is helpful to management to know how much cash flow it may receive if it were to sell the desk at the end of its useful life residual value vs resale valueresidual value and resale value are two terms that are often used when discussing car purchasing and leasing terms using the example of leasing a car the residual value would be a car s estimated worth at the end of its lease term residual value is used to determine the monthly payment amount for a lease and the price the person holding the lease would have to pay to purchase the car at the end of the lease the residual value of cars is often expressed as a percentage of the manufacturer s suggested retail price msrp for example residual may be expressed this way 30 000 msrp residual value of 50 15 000 value after 3 years so a car with an msrp of 30 000 and a residual value of 50 after three years would be worth 15 000 at the end of its lease resale value is a similar concept but it refers to a car that has been purchased rather than leased so resale value refers to the value of a purchased car after depreciation mileage and damage while residual value is pre determined and based on msrp the resale value of a car can change based on market conditions if you decide to buy your leased car the price is the residual value plus any fees calculating depreciation amortization using residual valueresidual value also figures into a company s calculation of depreciation or amortization suppose a company acquires a new software program to track sales orders internally this software has an initial value of 10 000 and a useful life of five years to calculate yearly amortization for accounting purposes the owner needs the software s residual value or what it is worth at the end of the five years assume this value is zero and the company uses the straight line method to amortize the software therefore the company must subtract the residual value of zero from the 10 000 initial value and divide by the asset s useful life of five years to arrive at its yearly amortization which is 2 000 if the residual value were 2 000 the yearly amortization would be 1 600 10 000 2 000 5 years for tangible assets such as cars computers and machinery a business owner would use the same calculation only instead of amortizing the asset over its useful life he would depreciate it the initial value minus the residual value is also referred to as the depreciable base 