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Scrap value is a term primarily used in finance in relation to depreciation. It is the projected value of an asset at the end of its projected useful life. This value affects the calculations used for producing the depreciation figures for financial accounts. The term “scrap” can also be used for a related meaning in insurance, specifically in deciding the payout if a car is written off.
Depreciation is both the concept that an asset loses value over time, and the accounting customs used to reflect this concept. The loss of value might be the result of physical deterioration, for example a machine wearing out. It could also be the result of an asset becoming obsolete, for example a computer that is eventually unable to run the latest edition of the software a company needs to use.
Both accounting customs and U.S. tax laws allow companies to break down this total loss of value in annual chunks, rather than wait until the asset really is useless. This helps avoid accounts suddenly showing a significant loss that may give a misleading impression into the company's annual accounts. It also spreads out the benefit the company gets by counting a portion of the loss against its taxable profits.
Once an accountant has assigned a predicted useful lifespan to the asset, which may be fixed by tax laws, he must decide what if any scrap value the asset will have at the end of this lifespan. This figure is also known as residual value. Scrap value can vary immensely: in the example of the worn out machine it may simply be the money that can be raised selling the metal to a salvage yard; in the example of the computer it could be a reasonable proportion of the purchase price if it is still in working order and could be useful to a second-hand buyer with less demanding software needs.
The accountant then deducts the scrap value from the purchase price to determine the total amount of depreciation for accounting purposes, and then breaks down this amount into chunks to be classed as a loss for each of the years during the asset's projected lifespan. Exactly how the amount is divided can vary: it may simply be equal portions, but other systems involve assigning larger portions during the early years. At the end of the lifespan, the actual scrap value of the asset must be calculated. The difference between this and the original projected scrap value must be added to that year's accounts as a profit or loss to balance the books.
Scrap value can also be used for insurance purposes, most notably auto insurance. If a car is involved in an accident and the insurer calculates the costs of repair would exceed the current value of the car, it will write off the car and pay what is known as a total loss settlement. This is the current market price for the car of the age and condition it was in before the accident, minus the scrap value. This reflects the fact that, theoretically at least, the owner could make back some money by selling the wreck for salvage.
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