Can we depreciate asset below residual value?


Main purpose of depreciation is to reduce the value of asset over its useful life in such a systematic way that such reduction corresponds with the rate at which benefits are rendered from the assets. To learn more about what is depreciation? You can visit this page.

International Accounting Standard (ISA) 16 Property plant and equipment is very clear on this aspect and clearly instructs that carrying value of the asset cannot be below residual value (residual value is also known as scrap value, disposal value etc). So total depreciation over the period of use or simply accumulated depreciation cannot exceed beyond a certain limit rendering net book value of asset below its expected scrap value of the asset.

IAS 16 defines residual value as follows:

The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life.

However, as residual value is an estimate which is required to be made at the time of acquisition of asset on present value basis, it may change during the course of life due to several factors. In such a case entity has to adjust its depreciation charge accordingly. If for a certain period if scrap value has been redetermined and it is found that residual value is expected to be more than expected then remaining carrying value must be spread over the remaining useful life to normalize depreciation charge over remaining useful life. If scrap value, as a result of revaluation or any other reason, found to be more than carrying amount of the asset than entity will stop depreciating the asset and for any subsequent periods depreciation change will be zero.

Depreciation charge will remain zero until scrap value exceeds carrying amount. Depreciation will resume only if scrap value fell below current book value of the asset. In simple words for a depreciation to be recognized asset must have associated devaluation of asset.

In short IAS 16 does not allow depreciating assets below residual value of the asset.