Residual Value

Intermediate

Residual value is the estimated amount an asset will be worth, or could be sold for, at the end of its useful life, after deducting the expected costs of disposal.

Residual value, also called salvage value, reduces the total amount that is depreciated over an asset's life. Only the difference between cost and residual value is spread across the years of use.

For example, a machine costs 50,000, is expected to be used for five years and to be sold for 5,000 at the end. The depreciable amount is 45,000, so straight-line depreciation is 9,000 a year rather than 10,000.

Residual values are estimates and are reviewed regularly. If a company expects to sell its vehicles for more than originally thought, it raises the residual value and reduces future depreciation.

The term is also important in leasing. In a car lease, the residual value is the expected value of the car at the end of the lease. Lease payments largely cover the difference between the car's price and its residual value, so a higher residual value usually means lower monthly payments. If the car is worth less than expected at the end, whoever bears that risk, the leasing company or the customer, takes the loss.

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