The residual value of an asset or property can be simply explained as the worth of an asset at the end of its lease period or useful life. It is one of the major and significant elements of leasing calculus. In accountancy, residual value is also called salvage value which is the fully depreciated worth of an asset.
The residual value of an asset, in the light of accounting, is described as its estimated amount which can be obtained at the time of its disposal after completion of its useful life.
Suppose you purchase a car from bank on five year leasing, its residual value in this case would be its worth at the end of five years. The bank determines its residual value before the lease period starts. Residual value in leasing case is determined on past models and future forecasts. In addition to other factors, it is also an important factor for determining the monthly lease payment. In capital budgeting projects, residual value is used to estimate the selling cost of an asset over lease period is over.
In case of useful life, residual value reflects the cost or worth of the asset at the end of its useful life. For example, if you purchase a machine with an expected useful life span of ten years, residual value will be used to determine the depreciated cost at the end of ten years. Some companies when purchase expensive machineries or tools, purchase residual value insurance so as to guarantee the value of their well maintained asset at the end of useful life.
Factors Affecting Residual Value
Residual Value is calculated from the base price after depreciation. However, there are various factors which are related to residual value of an asset. In general terms these factors include running or usage of the asset, its maintenance, expected life span, disposal performance and recent market trends etc. For example, residual value of car depends upon its mileage, seasonality, life cycle, disposal performance.