What is Scrap Value?
Scrap value or salvage value is the fixed asset value at the end of its useful life. At the end of the useful life, fixed assets still exist and of course, they still contain some value. The value may be varied depending on the type of assets. Some plant assets may contain scrap value of a few hundred up to a few hundred thousand. While the other assets have almost zero value. However, it just a small percentage of the fixed asset’s full value. So the higher fixed assets costs, the higher the scrap value.
Only the tangible asset has scrap value as the asset still exists after the end of useful life. Intangible asset value will decrease to zero at the end of useful life as they are useless.
Scrap Value Example
For example, company ABC purchases a vehicle that costs $ 100,000 to transport goods from one location to another. The company expects to use the vehicle for 5 years which is a useful life. At the end of the 5th year, it does not mean that the asset value goes to zero. There are still some remain, at least the value of the metal which can be sold. If the company takes good care of the vehicle, it may still work and it has more value. The company estimate that the value of the vehicle will remain around $ 10,000 at the end of useful life.
This amount needs to deduct from the total amount to calculate the depreciation expense.
Depreciation Expense = (Cost – Scrap Value)/ Useful life
Depreciation Expense = (100,000-10,000)/5 = $ 18,000 per year.
How Scrap Value Impact the Financial Statement
The scrap value has an indirect impact on both the income statement and balance sheet. As we know, it can influence the depreciable amount and depreciation expense.
Depreciation expense is one of the components in the income statement. So the higher the depreciation expense the lower the company’s net profit. When a company estimates a huge scrap value, it will reduce the depreciable amount and also decrease the deprecation expense.
Fixed asset balance will present in the balance sheet as the net book value, cost less accumulated depreciation. If the depreciation is lower, it will increase the fixed assets’ net book value. In order words, it will increase the company’s assets.
Under and Over Estimate Scrap Value
Scrap Value is the estimated balance of an asset after it is fully depreciated. We estimate this balance so that we can calculate the depreciation expense. Due to the estimation, it can be different from the actual value at the end of useful life.
When scrap value is overestimated, it means we can sell assets at a lower price than what we expect. It will make the disposal loss which is the other operating loss on the income statement. On the other hand, underestimate scrap value will generate a gain on disposal. So if the amount is significant, there will be a huge impact on the
Management should use proper historical and other available information to estimate the scrap value as it will have a huge impact on the financial statements. It does not mean we have to eliminate the difference between estimation and actual as it is almost impossible. We need to minimize the difference to the acceptable level which has only a small impact on financial statements.
