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INTRODUCTION
Salvage and cost of removal are important components in the calculation of book depreciation rates for both regulated and non-regulated companies. Historically, the approach used to recognize salvage and cost of removal in the capital recovery process has been to adjust the depreciation rate to include the estimated net salvage in the annual accrual. This is typically accomplished by using some form the equation (1-Net Salvage)/Life. As long as salvage ratios are near zero, the effect on the annual accrual is minimal. The assumption of zero or near zero net salvage is commonly made, and as a result, little attention has been given to the estimation of salvage values, and even less attention is given to the problem of including cost of removal in the calculation of depreciation accruals.
The effect of salvage on the depreciation calculation has been largely ignored by accountants. The assumption that scrap proceeds will equal the cost of removal, i.e. that net salvage will be zero, has been an accepted approach. However, negative net salvage has become a real problem for many capital intensive industries. Although current discussions of negative net salvage are taking place mainly within the regulated industries, the problem is also common in the non-regulated sector. Greater societal concern about the environment may force non-regulated companies to incur material negative salvage costs by requiring removal of their facilities after the service life is over, rather than following the current practice of simply abandoning them.
In the regulated sector, negative salvage is treated in a variety of ways depending on the regulatory jurisdiction and the type of industry. Various treatments have evolved including simply adjusting the annual accrual for estimated negative net salvage, expensing cost of removal at the time of retirement, and setting up separate reserve accounts for gross salvage and cost of removal. These approaches have different consequences with respect to the recovery of capital and matching expenses with revenues.
DEFINITIONS AND EXAMPLES
Gross salvage is the amount received from material which is recovered when an asset is removed from service. Gross salvage can be received at any time in an asset's life, and the amount may vary depending on the age of the asset. Issues such as reuse, location life, sale to another company,...