Residual value definition
Residual value is defined as the remaining value existing in a physical or financial asset at the end of its useful life. The accepted residual value definition refers to the fair market value of the asset; for physical assets, it is often called salvage value since it is the value that can be reclaimed by salvaging or selling off the asset after its useful life is done. The useful life of a physical asset does not refer to its working life; many fully-depreciated physical assets are still in working order and can perform their expected functions. Useful life is instead the period of time established by the IRS after which an asset is considered fully depreciated; the IRS publishes extensive depreciation tables for almost every type of physical asset.
Residual value formula
In most cases, residual value is calculated based on the current condition of the specific asset; for instance, an automobile might be evaluated based on current blue book prices for its model, make, year, and physical condition. For other assets, the residual value formula is derived by multiplying the percentage of value remaining by the original value of the asset, as in:
- Residual value formula = Original value of asset * percentage of value remaining
Negative residual value
In certain special cases, the residual value of an asset may be negative; this only occurs when there are significant disposal costs for the asset. One relatively common example of this is found in companies that must use hazardous material in the course of their regular business; the cost of disposing of the materials and contaminated equipment at the normal end-of-life of these assets may be more than the actual remaining value of the assets themselves.
Residual value and auto leasing
For companies and individuals who lease vehicles rather than purchasing them, residual value is an important consideration since it is one of the main factors in determining the monthly leasing costs for the vehicle. Because leased vehicles are typically returned to the leasing company at the end of the contract, the lease does not cover the entire cost of the vehicle. Instead, leasing companies subtract the estimated residual value of the vehicle at the end of the lease from the original cost and amortize the resulting figure over the entire lease period; this provides a base figure for monthly lease payments on the vehicle.