Add salvage value floor complication with reduced scaffolding
Complication: The Salvage Value Floor
There is one critical rule in DDB that students often miss: book value can never fall below salvage value. This means that in the later years of an asset's life, the DDB calculation may produce an expense that is too large. When that happens, you must adjust the expense downward.
If the calculated DDB expense would push book value below the salvage value, replace the calculated expense with the amount that brings book value exactly to the salvage value. In the final year, the expense is often a "plug" figure.
Worked Example: When the Floor Kicks In
| Year | Begin BV | Raw DDB (40%) | Adjusted Expense | End BV | Note |
|---|---|---|---|---|---|
| Year 1 | $30,000 | $12,000 | $12,000 | $18,000 | Normal |
| Year 2 | $18,000 | $7,200 | $7,200 | $10,800 | Normal |
| Year 3 | $10,800 | $4,320 | $4,320 | $6,480 | Normal |
| Year 4 | $6,480 | $2,592 | $1,480 | $5,000 | Floor hit! |
| Year 5 | $5,000 | $2,000 | $0 | $5,000 | Already at salvage |
In Year 4, raw DDB would be $2,592, which would push book value to $3,888 — below the $5,000 salvage value. So the expense is capped at $1,480 ($6,480 − $5,000). Year 5 has zero expense because the asset is already at salvage value.
Why does the salvage value floor exist? What would happen to the financial statements if book value fell below salvage value?
The salvage value represents what the company expects to recover when it sells the asset. If book value fell below that amount, the company would be recording more expense than the asset actually lost in value — which would understate profit and mislead investors.
Key insight: The salvage value floor is the most common DDB mistake on exams and in practice. Always check: would this year's expense push book value below salvage? If yes, adjust.
Scenario: A $20,000 machine with 4-year life and $2,000 salvage value. DDB rate = 50%.
Year 1: $20,000 × 50% = $10,000. BV = $10,000. Normal.
Year 2: $10,000 × 50% = $5,000. BV = $5,000. Normal.
Year 3: $5,000 × 50% = $2,500. But $5,000 − $2,500 = $2,500, which is above $2,000 salvage. So $2,500 is fine. BV = $2,500.
Year 4: $2,500 × 50% = $1,250. But $2,500 − $1,250 = $1,250, which is BELOW $2,000 salvage. Expense is capped at $500. BV = $2,000.