OCW041: Disposal of Assets

Sale

The disposal sale of an asset is similar to a regular asset sale, where cash proceeds are received and a loss or gain may be realized.

Learning Objectives

Summarize how a company records the sale of an asset for disposal purposes

Key Takeaways

Key Points

  • When an asset set for disposal is sold, depreciation expense must be computed up to the sale date to adjust the asset to its current book value.
  • Compare the cash proceeds received from the sale with the asset’s book value to determine if a gain or loss on disposal has been realized. The gain or loss should be reported on the income statement.
  • The asset account and its accumulated depreciation account are removed off the balance sheet when the disposal sale takes place.

Key Terms

  • depreciation: The measurement of the decline in value of assets. Not to be confused with impairment, which is the measurement of the unplanned, extraordinary decline in value of assets.
  • book value: The value of an asset as reflected on an entity’s accounting books, net of depreciation, but without accounting for market value appreciation.
  • realize: To acquire as an actual possession; to obtain as the result of plans and efforts; to gain; to get.

Disposal of an Asset via Sale

The sale of an asset for disposal purposes is similar to a regular asset sale. Unlike a regular disposal of an asset, where the asset is abandoned and written off the accounting records, an asset disposal sale involves a receipt of cash or other proceeds. When the sale takes places, a journal entry is recorded that (1) updates depreciation expense, (2) removes the asset and its accumulated depreciation account off the balance sheet, (3) increases cash or other asset with the amount of proceeds received, and (4) records a gain or loss on the sale.

Depreciation Expense at Disposal

At the time of disposal, depreciation expense should be recorded to update the asset’s book value. A journal entry is recorded to increase (debit) depreciation expense and increase (credit) accumulated depreciation. Depreciation expense is reported on the income statement as a reduction to income. The increase in the accumulated depreciation account reduces the asset to its current book value.

image

An Asset for Sale — one way of disposing an asset is by selling it.: A business disposing of a building through a sale receives cash proceeds and may realize a gain or loss.

Proceeds Received and Loss/Gain at Disposal

The proceeds received on the asset sale are compared to the asset’s book value to determine if a gain or loss on disposal has been realized. If the proceeds are less than book value, a loss on disposal has been realized. If the proceeds are more than book value, the result is a gain. The proceeds from the sale will increase (debit) cash or other asset account. Depending on whether a loss or gain on disposal was realized, a loss on disposal is debited or a gain on disposal is credited. The loss or gain is reported on the income statement. The loss reduces income, while the gain increases it.

Asset Disposal and the Balance Sheet

The entry to remove the asset and its contra account off the balance sheet involves decreasing (crediting) the asset’s account by its cost and decreasing (crediting) the accumulated depreciation account by its account balance. Prior to zeroing out their account balances, these accounts should reflect the updated depreciation expense computed up to the disposal sale date.

Involuntary Conversion

Involuntary conversion of assets occurs when disposal is due to unforeseen circumstances, such as theft or casualty.

Learning Objectives

Explain how a company accounts for the involuntary conversion of an asset

Key Takeaways

Key Points

  • The forced disposal of the asset may result in cash proceeds from the filing and payment of an insurance claim on the asset or the receipt of a casualty award. A gain or loss on disposal can result.
  • Involuntary conversion of assets can involve an asset exchange for monetary or non-monetary assets.
  • An involuntary conversion involving an exchange for monetary assets is accounted for the same way as a sales transaction, with a gain or loss reported on the income statement.
  • An exchange between non-monetary assets should be analyzed to determine if the exchange has commercial substance. An asset exchange with commercial substance will cause future cash flows to materially change.
  • A non-monetary asset exchange with commercial substance may result in a gain or loss reported on the income statement. An exchange without commercial substance does not recognize gains or losses.

Key Terms

  • casualty: Something that happens by chance, especially an unfortunate event; an accident, a disaster.
  • condemnation: The process by which a public entity exercises its powers of eminent domain.
  • depreciation: The measurement of the decline in value of assets. Not to be confused with impairment, which is the measurement of the unplanned, extraordinary decline in value of assets.

Definition of Involuntary Conversion

The involuntary conversion of an asset occurs when an asset must be disposed of due to unforeseen circumstances, such as theft, casualty, or condemnation. The forced disposal of the asset may result in cash proceeds from the filing and payment of an insurance claim on the asset or the receipt of a casualty award. If the monetary exchange is more than the asset’s book value, updated for depreciation up to the disposal date, a gain on disposal results; if the proceeds are less, the disposal realizes a loss. Unlike a voluntary sale, involuntary conversion of assets can involve an asset exchange for monetary or non-monetary assets.

image

An involuntary conversion is the forced disposal of an asset.: An airplane manufacturer’s involuntary conversion of a plane can result in a loss or gain on the income statement.

Exchange for Monetary Assets

Monetary assets consist of cash or cash-equivalent assets. An involuntary conversion involving an exchange for monetary assets is accounted for the same way as a typical sales transaction, with a gain or loss reported in the income statement in the period the conversion took place. The gain or loss is the difference between the proceeds received and the book value of the asset disposed of, updated for current depreciation expense.

Exchange for Non-Monetary Assets

Non-monetary assets are not easily converted to cash, such as equipment. An exchange between non-monetary assets should be analyzed to determine if the exchange has commercial substance. An asset exchange with commercial substance will cause future cash flows to materially change. If the exchange has commercial substance, the asset received is recorded on the balance sheet at either (1) the market value (purchase price) of the asset received or (2) the market value of the asset given up plus any cash paid. If the value of the new asset exceeds the book value of the old asset, a gain is recognized. If the new asset’s value is less, a loss is recognized.

For non-monetary asset exchanges without commercial substance, the expectation is that the exchange will not materially alter future cash flows. This type of exchange usually involves like-kind property, such as exchanging a truck for another truck. The asset received is recorded on the balance sheet at the book value of the asset given up plus any cash paid. Gains or losses on these transactions are not recognized.


Source: Accounting