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Disposal of Capital/Fixed Assets

Disposal of Capital/Fixed Assets

Author: Evan McLaughlin

In this tutorial, the student will learn about disposal of capital/fixed assets.

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"Disposal of Capital/Fixed Assets"

Source: Instrumental “Drops of H2O ( The Filtered Water Treatment )" by J.Lang (feat. Airtone),” Creative Commons, http://ccmixter.org/files/djlang59/37792

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Hey, everyone, and welcome to our video, today-- Disposal of Capital/Fixed Assets. So what's today's video about? Well, it's about the disposal of assets. We're going to talk about disposing of assets, recording the disposal, and we're going to finish up by looking at calculating gains and losses.

So let's start by discussing asset disposal. What is an asset disposal? It's selling, donating, or removing an asset from the business, so the business no longer owns or uses the asset. Why would an asset be disposed of? The asset may have reached the end of its useful life, and a company may need to upgrade the asset, so they may need an asset that has increased utility, quality, efficiency, a different style-- because there's new manufacturing techniques or equipment, or an asset that has a different functionality.

So how do we dispose of an asset? Well, there are several ways. We can throw it away, you can donate it, or you can sell it. Now, when you sell it, there are a few different outcomes. You can sell it for a gain, a loss, or no gain or loss. So you sell it for the book value, which we'll look at those, more closely, a little bit later.

But let's start talking about recording the disposal. So the first piece is to record depreciation. So, prior to recording, depreciation expense needs to be recorded through the date of disposal. So, before we record our disposal, we need to record our depreciation expense, through the date of disposal-- regardless of the disposal method. So whether we donate it, sell it, or scrap it, we need to perform this step.

Why do we need to do that? Well, we need to have an accurate book value, or carrying value, prior to recording the disposal. Now, book value is the cost of a depreciable asset, less its accumulated depreciation. And carrying value is the book value of an asset cost, less accumulated depreciation. So we need to have an accurate value, in order to properly record the disposal.

So the best way to illustrate this is with an example. So let's go ahead and take a look at one, now. We have ABC Company that disposes of equipment on June 30, 2013. The equipment cost $50,000, was purchased January 1, 2010, and has a useful life of five years. So now, this company uses straight-line depreciation, which means, with the cost and useful life, depreciation is $10,000 per year.

And now depreciation has been recorded through 12/31/12-- so, through the end of last year-- so accumulated depreciation is $30,000. So what is the depreciation-expense journal entry that we need to record? Well, we're going to have a debit to depreciation expense, and a credit to accumulated depreciation. But for what amount?

Well, if our straight-line depreciation is $10,000 per year, and this is being disposed of after six months of the year, we take that straight-line depreciation, multiply it by the fraction of the year that we need to record it for, and that gives us $5,000. So we would record an entry to depreciation expense and accumulated depreciation of $5,000.

So that's how we record depreciation, prior to disposal. Now let's start talking about gains and losses. So now, we're going to be recording our asset disposal. So the asset, and all of its related accounts, must be removed from the books . So we're taking everything related to this asset off the books.

In order to do that, we make an entry to the opposite side of the natural balance. So an asset is removed with a credit, and accumulated depreciation is removed with a debit. So now, when we sell an asset, an asset will be sold at market value. And what's market value? That's the price at which an asset could be bought or sold. So the market value is what someone is willing to pay us for that asset. So if we sell it, we're going to get market value.

And remember, there are three outcomes. We can sell it for a gain, which is, the asset is sold for more than carrying value; we can sell it at a loss, which means our asset is sold for less than the carrying value; or we can sell it for no gain or loss, which means our asset is sold for the carrying value.

So now let's look at some examples of each of these scenarios. We're going to stick with the same example. We have that same $50,000 of equipment. We've now recorded our depreciation, through June 30, the date of our disposal. So now, our accumulated depreciation is $35,000, which, given the cost of our equipment and the accumulated depreciation, gives us a carrying value of $15,000.

So our first scenario. Market value is $20,000. Let's take a look at what that does for our entry. So if we have a market value of $20,000, that means we're gonna get $20,000 in cash. We have to remove that accumulated depreciation. We have to remove our equipment. And then we would record a gain of $5,000.

Well, how do we compute that gain? $20,000 sale price, minus the carrying value of $15,000, results in a $5,000 gain. So that's our first scenario.

Next scenario. The market value of that asset is $5,000. So let's take a look at that scenario. So the cash that we're going to receive-- because it's the market value-- is $5,000. Again, we still need to remove our accumulated depreciation; remove our equipment. And then we would need to record a loss. So how do we calculate that loss? A $5,000 sale, minus a $15,000 carrying value, results in a $10,000 loss. So that's how we determine our loss.

Now, our last scenario-- scenario number three. Market value is $15,000. So what does that look like? So, since market value is $15,000-- that's how much cash we're going to receive-- we have to remove our accumulated depreciation from the books, remove our equipment from the books, and that's it; we're done.

Why? Because it was a $15,000 sale, and we have a $15,000 carrying value, so there's no gain or loss. We sold the asset for its carrying value-- for its book value. So those are the three scenarios that you can have, when you're selling an asset. You can sell it at a gain, a loss, or for no gain or loss.

Let's summarize what we talked about, today. In a nutshell, we looked at disposal of capital/fixed assets. We talked about why we dispose of assets, we looked at recording the disposal-- so we have to record depreciation expense, and then we can record the disposal-- and we looked at calculating gains and losses on that sale of the asset.

I hope everybody enjoyed this video, and I hope to see you next time.

  • Market value

    The price at which an asset could be bought or sold.

  • Book value

    The cost of a depreciable asset less its accumulated depreciation.

  • Carrying value

    The book value of an asset, cost less accumulated depreciation.