Page 75 - Account for Ag - 2019

CH 12] Accounting for Fixed Assets & Depreciation 12-3

SALVAGE VALUE
When a fixed asset has a salvage value, the cost of its fund of usefulness is its cost minus its salvage value.

The salvage value of a fixed asset is that portion of its cost that is recovered at the end of its productive life.
Some assets such as typewriters, trucks, and automobiles are traded in on similar new assets at the end of their
service lives. The salvage values of some assets are their trade-in values. Other assets may have no trade-in value
and little or no salvage value. For example, at the end of its service life, some machinery can be sold only as scrap
metal. The salvage value of such assets is the amount received from the sale of the scrap metal.

When the disposal of a fixed asset involves certain costs, as in the wrecking of a building, the salvage value is
the net amount realized from the sale of the asset. The net amount realized is the amount received for the asset less
its disposal cost.

Obviously, when a fixed asset is purchase, its exact salvage value is difficult to estimate. Yet, salvage value
must be estimated so that depreciation can be estimated and recorded.

TOTAL ALLOWABLE DEPRECIATION
For the purposes of this discussion, Total Allowable Depreciation (TAD) is a calculation that expresses the
total depreciation a business would take, if that business were to maintain a fixed asset throughout its useful 12
economic life. Total Allowable Depreciation is equal to the cost of the asset minus its determined salvage value.

Total Allowable Depreciation = Cost - Salvage Value

Under the current IRS code, depreciation taken on an asset may not exceed, over the economic life of that
asset, more than the calculation of Total Allowable Depreciation. That is depreciation may be taken at the
calculated rate for each accounting period, until the assets Total Allowable Depreciation has been reached; at
which point no more depreciation may be taken.

ALLOCATING DEPRECIATION
Many methods of allocating a fixed asset's total depreciation to the several accounting periods in its service life
have been suggested and are used. Six of the more common are the straight-line method, the units of production
method, the declining balance method, the sum of years digits method, and the Accelerated Cost Recovery System
method and Modified Accelerated Cost Recovery System. It should be noted that each of these are METHODS of
calculating depreciation (here defined as a procedure) which is an arithmetic process. Once a method has been
defined for an asset, that method may not be changed, unless the asset is sold or traded.

Straight-Line Method. When the straight-line method is used in allocating depreciation, the cost of the asset
minus its estimated salvage value is divided by the estimated number of accounting periods in its productive life.
The result of this calculation is the estimated amount the asset depreciates each period. For example, if a machine
costs $550, has an estimated service life of five years, and an estimated salvage value of $50, its depreciation per
year by the straight-line method is $100 and is calculated as follows:

Cost - Salvage $550 - $50
= = $100
Service Life 5

Note that the straight-line method allocates an equal share of the cost of an asset's fund of usefulness or an
equal share of its total depreciation to each accounting period in its life.

Units of Production Method. The primary purpose of recording depreciation is to charge each accounting
period in which an asset is used with a fair share of depreciation. The straight-line method charges an equal share
to each period; and when fixed assets are used about the same amount in each accounting period, this method
rather fairly allocates total depreciation. However, in some lines of business the use of certain fixed assets varies
greatly from accounting period to accounting period. For example, a contractor may use a particular piece of

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