Assume you are an assistant controller for a company. While you are preparing quarterly budget figures, it occurs to you that there are no residual values for the long-lived assets. You discuss this with the division director and he has specified that assets be given a residual value of zero. The director believes that estimates are “accounting magic” and have doubtful value. Although he can accept the estimate of a finite useful life, he believes that the residual is no more than a guess and has no place in his business. “Who knows what they’ll be worth when we’re through with them?” He says that the division always negotiates the best price possible when the assets are replaced, and takes any gain or loss at that time, when a “real” number is available.
Please respond to all of the following questions:
1. What should you do? Consider the following items in your answer:
2. What is a residual value? How is it determined? Why is it subtracted from cost before depreciation expense is calculated?
2. What impact does the choice (or lack) of a residual value have on the income statement and balance statement of an entity in the year the asset is purchased? During the asset’s life? In the year of the disposal of the asset?
4. Which fundamental accounting principle(s) govern(s) this situation?
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