Residual Value:How and Why to Account for it
Residual value is the amount of money that can be received at the end of an assets life. Residual value can vary widely and sometimes the asset will be worthless in the end. Even so, if a company is planning on salvaging the asset after its useful life, the salvage value of the asset must be accounted for. Some companies will use the residual value of one asset, to lower the initial cost of the replacing asset.
If no residual value is set, the depreciation will in return be higher, causing an unfair amount to be depreciated each year. So each year, the accounting of the company will be incorrect. To then take the residual amount off of the purchase to replace it, also has several issues. First the amount of the next asset would be skewed, lower than it actual is. Also, some assets will not be replaced with like assets, so there will be no asset purchase amount to tack the residual value of the previous asset.
The proper way to account for residual value is to estimate the salvage amount of the asset and to subtract it from the beginning price. The resulting figure should then be applied to the longevity of the asset to determine the annual depreciation value using whatever method the company uses; Units of production method, Straight-line method or Accelerated depreciation method.