International Accounting Standard (IAS) 16 recognizes that residual value of asset may increase or decrease as a result of revaluations or future assessments of non-current asset. IAS 16 recognizes such change as a change in accounting estimate i.e. adjustment will be prospective in nature. There is no need to adjust for previously recorded depreciation charge in the financial statements.
Residual value of fixed asset is the estimated amount at the date of purchase the asset would fetch if it is of same condition as it will be at the end of its useful life. So it is somewhat present value of residual value that asset will be bring when it is finally disposed off. To learn more about how residual value is valued please read: Is Residual value of the asset calculated on Present value or Future value basis?
Residual value helps in determining the depreciable amount of asset and the same is spread over the useful life of the asset. In straight line method a fixed portion of depreciable amount is transferred to income statement as expense from the cost of fixed asset recognized in the financial statements. In case of reducing balance method residual value is considered while determining the depreciation rate. In some cases the residual value is negligible and thus ignored in depreciation calculation on the basis of immateriality.
If residual value is material in that case any change in residual value will be adjusted in future calculations of depreciation calculations by simply deducting the revised residual value from the carrying amount of asset in the year residual value changed.
If this is hard to understand than remember most often change in residual value results from revaluation of assets and revaluation eliminates any previously recognized depreciation. Therefore, the revalued amount of asset will be the carrying amount of asset and residual value will be deducted from the same to compute depreciable amount which is to be reduced over the remaining useful life of asset. Consider the following example for better understanding.
Residual value can increase or decrease as a result of assessment. Treatment is same in both the cases. However, if residual value equals the current carrying value of fixed asset or exceeds it then depreciation for such asset will be halted until the time residual value reduces below the carrying amount of asset.
Example – Decrease in residual value
ABC company bought an asset for 100,000. Asset is expected to be used for 10 years and depreciated on straight line basis at 10% rate. Asset is expected to sell for 10,000 at the end of its useful life. At the end of year 7 residual value of asset is found to be 6,000 only. Compute depreciation charge for 10 years.
| Cost of the asset Less: Residual value |
100,000 (10,000) |
| Depreciable amount | 90,000 |
Depreciation for:
| Year 1: Year 2: Year 3: Year 4: Year 5: Year 6: |
90,000 / 10 90,000 / 10 90,000 / 10 90,000 / 10 90,000 / 10 90,000 / 10 |
9,000 9,000 9,000 9,000 9,000 9,000 |
Carrying amount at year 7: 100,000 – 54,000 = 46,000
Revised depreciable amount = 46,000 – 6,000 = 40,000
Depreciation charge per year for next 4 years (including year 7): 40,000 / 4 = 10,000
From above example you can see the amount by which residual value has reduced is spread over the remaining useful life of the asset. The net decrease was of 4,000 between original and revised residual value. The remaining useful life was 4 years and this 4,000 / 4 = 1,000 each year resulted in increased depreciation charge.
I would love to know what would be the effect to deferred taxes of the asset as at year end.
Hello Thank you for this guide.
1. What would change if it was an increase in residual value?
2. What would change in the example if this change happened during the last Cash Flow?
Thank you