Salvage Value

Salvage Value: When reading those two words what are the first ideas that come to your mind in regards of the definition? Depreciation, throwing away an expired television or maybe a value your beat up old vehicle is worth? Those all being good thoughts, but the correct definition is “The estimated value that an asset will realize upon its sale at the end of its useful life.” (INVESTOPEDIA.COM) You are probably asking, how does one estimate the price of an asset that is at the end of its useful life? Or also thinking of the best use or economic value. Determining the value of an asset is very easy and may spark up memories of your Managerial Accounting class as we use accounting principles along with depreciation. With that being said lets first investigate how to determine Salvage Value of a building that has been determined to have a better use.

Let’s say you would like to determine the salvage value of the building you conduct business in as it ages and has an opportunity to become of better use. First we know that when you built the building in 1990, it cost you $500,000 and it's now the year 2010. Next we would need to know the salvage value; the salvage value of the building is estimated at $80,000. How we get the estimated salvage value is by looking into what the comparables are worth in the current market. This is also known as market value, the price that the building could be sold at as of today. Now the accounting principles come into place. We would like to determine how much the building has depreciated in the past 20 years. In doing so we can guarantee that this is a reliable estimate and that the building will actually sell for what it’s worth or make more sense to demolish and rebuild for the best use.

Many businesses use this method to determine the salvage value of an asset, especially in businesses that have machinery, delivery trucks, and other expensive highly depreciating assets. If you’re not familiar with the term salvage value businesses also refer salvage value to residual value or scrap value. For our example we are using a business building that one owns as a personal investment, but we could also say it’s his or her interest in the building is no longer there since it's not being used for the best use. The building owner would like to determine if demolishing the building is more profitable than building on as he or she decides to change the use of the building into an apartment complex.

In our example we are using a straight line basis. The formula looks like this: Asset cost in 1990 = $500,000 and the salvage value as of 2010 are estimated at $80,000. Taking the cost of your asset in 1990, which was $500,000 and subtracting the salvage value $80,000 we get the amount below:

$500,000 - $80,000 = $420,000
Now take the years that have expired, which are 20 years and divide $420,000 by 20:

$420,000 ÷ 20 = $21,000

The $21,000 is your yearly depreciation, which goes to show you that buildings can depreciate at a large amount or what's around the building can cut the life of that building short. In this case we will say that more apartment complexes are being built instead of what it once was, commercial usage.

You can determine any asset’s salvage value by using this formula if you would like to estimate the value before you decide to sell the asset or do whatever you please to do with it. Say you determine the value to be so little that you demolish the asset, in our case the building. In order to gain some kind of profit and it to make sense you would want to determine this Salvage Value so you can have a clear picture on what your return might be. The owner of this building decides to demolish the building and actually receives more than the $80,000 that he or she would have got if they were to sell the building. Many companies saw the opportunity to use the reusable materials for their own construction use. Therefore in this case it was very valuable to determine the Salvage Value.

In the key words section of our text Salvage Value is present, but the text shows no interest in saying what it means. That made me curious as to what the text means when they use the term Salvage Value as one of the keys terms. Does it relate to trade fixtures which are assets or to much more? It’s much more than just trade fixtures. Like our example shows it can be materials recycled after a demolition and so much more. Salvage Value assets are mostly used for major divisions of your business. In the Real Estate field our Salvage Value assets will range from computers to vehicles and the best use of an asset, such as a building. I have learned that this is almost an exact estimation of what your asset is worth, especially since the market can back up the value estimated.

Rattermann, M. R. (2009). The Student Handbook to The Appraisal of Real Estate. Chicago, IL: Appraisal Institute.

INVESTOPEDIA.COM (2010). Salvage Value Definition. Retrieved from http://www.investopedia.com/terms/s/salvagevalue.asp