Disposal of Fixed Assets
Disposal of fixed assets is accounted for by removing the cost of the asset and the related accumulated depreciation from balance sheet, recording receipt or cash proceeds and recognizing any resulting gain or loss.
A company may need to derecognize a fixed asset either upon the sale of the asset to another party or when the asset is no longer operational and is disposed off.
Whether a de-recognition results in a gain or loss or no gain and loss depends on whether the cash proceeds (if any) from the sale are higher than the carrying amount of the asset at the time of disposal or not.
Disposal of an Asset with no Salvage Value
Where an asset’s salvage value is zero i.e. it does not generate any cash flows at the end of its useful life, there is no gain or loss.
Company A purchased a software for $100,000 on 1 January 2009. The software license was valid for four years. At the time of expiry, i.e. 31 December 2012, Company A shall record the derecognition/disposal as follows:
Gain on Disposal
When a fixed asset is sold for an amount higher than its carrying amount at the date of disposal, the excess of sale proceeds over the carrying amount is recognized as gain on disposal.
On 1 January 2006, Company B purchased equipment at a cost of $2 million. The company estimated its salvage value to be $0.2 million at the end of useful life of 5 years.
The company depreciated the asset on a straight-line basis i.e. $360,000 per year ((2,000,000 − 200,000) ÷ 5) resulting in the carrying amount as at 31 December 2010 of $0.2 million.
Actual proceeds from sale of the used asset turned out to be $0.5 million. Since the sale proceeds exceed the carrying amount by $0.3 million ($0.5 million − $0.2 million) so a gain is to be recognized using the following journal entry:
|Gain of disposal||300,000|
The equipment cost and the related accumulated depreciation are removed from balance sheet in the process of disposal and the gain is reported in income statement.
Loss on Disposal
If a fixed asset is sold at a price lower than its carrying amount at the date of disposal, a loss is recognized equal to the excess of carrying amount over the sale proceeds.
Company A purchased a specialized trading terminal for $4 million on 1 January 2006. The company expected the system to last 5 years and generate a residual value of $0.5 million.
However, due to rapid changes in technology, the company was forced to abandon the system only after 2 years for $1.5 million and invest in new infrastructure.
In the two years, the depreciation expense charged i.e. the accumulated depreciation on the terminal = ($4 million – $0.5 million) ÷ 5 × 2 = $1.4 million
Carrying amount at the time of disposal = $4 million – $1.4 million = $2.6 million
Since the cash proceeds ($1.5 million) are less than the carrying amount (i.e. $2.6 million), the disposal has resulted in a loss of $1.1 million ($2.6 million - $1.5 million).
Company C shall recognize the loss as follows:
|Loss of Disposal||1,100,000|
The accounting transaction results in removal of the trading terminal from balance sheet and recognition of the loss in income statement. Net effect on total assets is a decrease of $1.1 million (-$4,000,000 + $1,400,000 + $1,500,000) which is also reflected by equivalent decrease in shareholders’ equity.
No Gain or Loss on Disposal
If the carrying amount of a fixed asset at the date of disposal is equal to the sale proceeds from disposal, there is neither gain nor loss.
Company D sold an asset to Company Z for $ 2 million. Company Z depreciated the asset on straight-line basis for 4 years. Company D offered to buy-back the asset at $0.4 million at the end of useful life of the asset. Hence, Company Z estimated salvage value to be $0.5 million
Accumulated depreciation at the end of 4 years = ($2 million – $0.4 million) ÷ 4 × 4 = $1.6 million
Carrying amount at the end of 4 years = $4 million - $1.6 million = $0.4 million
Written by Obaidullah Jan, ACA, CFA