IAS 16 : Residual value

Residual value

The residual value is the net value of the asset at the end of its useful life. The initial residual value is determined at the start of the asset’s life using judgment.

An underatking is required to measure the residual value of an item of property, plant and equipment as:

the amount it estimates it would receive currently for the asset if the asset were already of the age and in the condition expected at the end of its useful life.

The depreciable amount of an asset is determined after deducting its residual value.

EXAMPLE residual value Your vehicle costs $20.000. You will sell it in 4 years time. The residual value is $8.000. The depreciable amount is $12.000 ($20.000-$8.000). The depreciation charge is $3.000 ($12.000/4) per year
	I/B	DR	CR
Property, plant & equipment	B	20.000
Cash	B		20.000
This records the buy of the vehicle
Depreciation	I	3.000
Accumulated depreciation	B		3.000
Annual depreciation

The residual value of an asset is often insignificant, and therefore immaterial in the calculation of the depreciable amount.

EXAMPLE        Difference between useful life and economic life Issue Useful life is defined as either: i) the period of time over which an asset is expected to be available for use by an undertaking; or ii) the number of production units the undertaking expected to be produced by the asset. What is the difference between an asset’s useful life and economic life? Background T’s management operates a branch. The fixtures and fittings in the branch have an economic life of ten years. The branch is located in a section of a leasehold building. The lease period is seven years and an extension of the lease appears unlikely. Solution The useful life of the fixtures and fittings is seven years because T is unlikely to use them after the lease expires. Useful life is the period over which management expects to use an asset. This is different from the asset’s economic life, which is the total period of time the asset is capable of providing economic benefits, whether to the bank or to a subsequent owner. A useful life that is shorter than the economic life may, however, result in a higher residual value at the end of the asset’s useful life. The level of the residual value will affect the calculation of the depreciation charge.

The residual value of an asset may increase to an amount equal to, or greater than, the asset’s carrying amount.

If it does, the asset’s depreciation charge is zero until its residual value subsequently decreases to an amount below the asset’s carrying amount.

EXAMPLE increase in residual value Your vehicle costs $20.000. You will sell it in 4 years time. The estimated residual value is $8.000. The depreciation charge is $3.000 per year. At the end of year 3, the carrying amount is $11.000. The residual value has increased to $9.000, due to increases in the prices of secondhand (used) vehicles. The depreciation charge for year 4 is reduced from $3.000 to $2.000, so the carrying value is the same as the residual value of $9.000. No change is made to depreciation charged in previous years.
	I/B	DR	CR
Depreciation	I	2.000
Accumulated depreciation	B		2.000
Depreciation for year 4

Unless the residual value of an asset is guaranteed, the residual value will only be an estimate of the amount that the undertaking will receive when it disposes of  the asset.

The higher the residual value, the lower will be the cost to the undertaking in depreciation charges. If the estimated residual value is too high, this will result in a loss on disposal and inflated profits in the periods before disposal.

Where PPE represents a material part of the asset structure, such as undertakings that lease PPE, the accuracy of residual values is the key to the accuracy of results.