How can the selection of useful life and salvage value affect the financial statements?

How can the selection of useful life and salvage value affect the financial statements?

Expert Solution

The computation of depreciation is affected by three factors: cost, useful life, and salvage value. Salvage Value is stated as anticipated value of a asset which is depreciable when it reaches the end of its Useful Life. If Salvage Value is set too high then the amount of depreciation will be under-expensed over the Useful Life; and as a result the net income will be over-stated. Retained earnings and total fixed assets will be overstated. In the similar manner if Salvage Value is set too low the depreciation amount will be over-expensed and consequently there will be understated net income. Retained earnings and total fixed assets will be understated as well. The metrics of Balance Sheet will be adversely impacted because the debt-to-equity ratio and loan collateral values will be decrease. Thus will lead to the violation of loan covenants and /or impair company's ability to obtain necessary future financing.

ekkarill92 answered 2 years ago

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