Change in residual value

Whilst we have discussed the term ‘residual value’, we haven’t really approached the matter of this being changed.

An asset’s residual value is an estimate the management makes using it’s best knowledge of the asset, it’s condition, it’s possible market at the end of it’s useful life, how extensively it will be used and so on. It’s not just the value the management believes they can get for the asset, but the conditions and inputs for determining the price. 

As it happens, life goes on, conditions change, markets change, businesses take new courses and assets themselves have a life of their own (i.e. they can break down, require earlier replacement or last longer than expected). Considering this it’s only natural than estimates change and when looking at an asset’s residual value you may find it’s really not what you expect to get for it in the light of the current situation. As such, the residual value of an asset should be changed and as it’s a change in management estimate, it’s done prospectively.

Note here that a change in the residual value begs to question if the useful life of the asset currently applicable is still true or if this ought to be changed as well. It should also be remembered that if the residual value changes, the monthly depreciation charge changes alongside with it since the amount being depreciated has changed.