4.7: Gains and Losses on Disposal of Assets
A company may no longer need a fixed asset that it owns, or an asset may have become obsolete or inefficient. In this case, the company may dispose of the asset. Prior to discussing disposals, the concepts of gain and loss need to be clarified.
A gain results when an asset is disposed of in exchange for something of greater value.
Gains are increases in the business’s wealth resulting from peripheral activities unrelated to its main operations. Recall that revenue is earnings a business generates by selling products and/or services to customers in the course of normal business operations. That is, earnings result from the business doing what it was set up to do operationally, such as a dry cleaning business cleaning customers’ clothes. A gain is different in that it results from a transaction outside of the business’s normal operations. Although in terms of debits and credits a gain account is treated similarly to a revenue account, it is maintained in a separate account from revenue. In that way the results of gains are not mixed with operations revenues, which would make it difficult for companies to track operation profits and losses—a key element of gauging a company’s success.
Similarly, losses are decreases in a business’s wealth due to non-operational transactions. Recall that expenses are the costs associated with earning revenues, which is not the case for losses. Although in terms of debits and credits a loss account is treated similarly to an expense account, it is maintained in a separate account so as not to impact the net income amount from operations.
Both gains and losses do appear on the income statement, but they are listed under a category called “other revenue and expenses” or similar heading. This category appears below the net income from operations line so it is clear that these gains and losses are non-operational results.
4.7.1 Disposal of Fixed Assets
There are three ways to dispose of a fixed asset: discard it, sell it, or trade it in.
- Discard - receive nothing for it
- Sale - receive cash for it
- Exchange (trade-in) - receive a similar asset for the original one
The first step is to determine the book value, or worth, of the asset on the date of the disposal. Book value is determined by subtracting the asset’s Accumulated Depreciation credit balance from its cost, which is the debit balance of the asset.
Next, compare its book value to the value of what you get for in return for the asset to determine if you breakeven, have a gain, or have a loss.
The company breaks even on the disposal of a fixed asset if the cash or trade-in allowance received is equal to the book value. It also breaks even of an asset with no remaining book value is discarded and nothing is received in return.
The company recognizes a gain if the cash or trade-in allowance received is greater than the book value of the asset.
A loss results from the disposal of a fixed asset if the cash or trade-in allowance received is less than the book value of the asset. The company also experiences a loss if a fixed asset that still has a book value is discarded and nothing is received in return.
Start the journal entry by crediting the asset for its current debit balance to zero it out. Then debit its accumulated depreciation credit balance set that account balance to zero as well. Build the rest of the journal entry around this beginning. Debit Cash or the new asset if either is received in exchange for the one disposed of, if applicable. Finally, debit any loss or credit any gain that results from a difference between book value and asset received.
Partial-Year Depreciation
Recall that when a company purchases a fixed asset during a calendar year, it must pro-rate the first year’s 12/31 adjusting entry amount for depreciation by the number of months it actually owned the asset.
A similar situation arises when a company disposes of a fixed asset during a calendar year. The adjusting entry for depreciation is normally made on 12/31 of each calendar year. If a fixed asset is disposed of during the year, an additional adjusting entry for depreciation on the date of disposal must be journalized to bring the accumulated depreciation balance and book value up to date.
Equipment that cost $6,000 depreciates $1,200 on 12/31 of each year. Accumulated depreciation on the equipment at the end of the third year is $3,600, and the book value at the end of the third year is $2,400 ($6,000 - $3,600).
Solution
Scenario #1
The equipment will be disposed of (discarded, sold, or traded in) on 4/1 in the fourth year, which is three months after the last annual adjusting entry was journalized. The first step is to journalize an additional adjusting entry on 4/1 to capture the additional three months’ depreciation. This ensures that the book value on 4/1 is current. Since the annual depreciation amount is $1,200, the asset depreciates at a rate of $100 a month, for a total of $300.
| Date | Account | Debit | Credit | ||
| 4/1 | Depreciation Expense | 300 | ▲ Depreciation Expense is an expense account that is increasing . | ||
| Accumulated Depreciation | 300 | ▲ Accumulated Dep. is a contra asset account that is in creasing . |
The asset’s book value on 4/1 of the fourth year is $2,100 ($6,000 - $3,900).
Scenario #2
The equipment will be disposed of (discarded, sold, or traded in) on 10/1 in the fourth year, which is nine months after the last annual adjusting entry was journalized. The first step is to journalize an additional adjusting entry on 10/1 to capture the additional nine months’ depreciation. This ensures that the book value on 10/1 is current.
| Date | Account | Debit | Credit | ||
| 10/1 | Depreciation Expense | 900 | ▲ Depreciation Expense is an expense account that is increasing . | ||
| Accumulated Depreciation | 900 | ▲ Accumulated Dep. is a contra asset account that is increasing . |
The asset’s book value on 10/1 of the fourth year is $1,500 ($6,000 - $4,500).
A company buys equipment that costs $6,000 on May 1, 2011. The equipment depreciates $1,200 per calendar year, or $100 per month. The company disposes of the equipment on November 1, 2014. How much depreciation expense is incurred in 2011, 2012, 2013, and 2014? What is the Accumulated Depreciation credit balance on November 1, 2014? What is the book value of the equipment on November 1, 2014?
Solution
| 2011 | $800 | May 1 through December 31 – 8 months | (Year of purchase) |
| 2012 | $1,200 | January 1 through December 31 – 12 months | |
| 2013 | $1,200 | January 1 through December 31 – 12 months | |
| 2014 | $1,000 | January 1 through November 1 – 10 months | (Year of disposal) |
| Accumulated Depreciation balance on November 1, 2014: | $4,200 ($800 + $1,200 + $1,200 + $1,000) |
| Book value of the equipment on November 1, 2014: | $1,800 ($6,000 - $4,200) |
Discarding a Fixed Asset (Breakeven)
When a fixed asset that does not have a residual value is fully depreciated, its cost equals its Accumulated Depreciation balance and its book value is zero.
The ledgers below show that a truck cost $35,000. It is fully depreciated after five years of ownership since its Accumulated Depreciation credit balance is also $35,000. The book value of the truck is zero (35,000 – 35,000).
Solution
| Truck | Accumulated Depreciation | |||||||||||
| Date | Item | Debit | Credit | Debit | Credit | Date | Item | Debit | Credit | Debit | Credit | |
| 1/1 | 35,000 | 35,000 | 12/31 | 7,000 | 7,000 | |||||||
| 12/31 | 7,000 | 14,000 | ||||||||||
| 12/31 | 7,000 | 21,000 | ||||||||||
| 12/31 | 7,000 | 28,000 | ||||||||||
| 12/31 | 7,000 | 35,000 |
Compare the book value to what was received for the asset . The truck is not worth anything, and nothing is received for it when it is discarded. If the truck is discarded at this point, there is no gain or loss. Both account balances above must be set to zero to reflect the fact that the company no longer owns the truck.
To record the transaction, debit Accumulated Depreciation for its $35,000 credit balance and credit Truck for its $35,000 debit balance.
| Date | Account | Debit | Credit | ||
| 12/31 | Accumulated Depreciation | 35,000 | ▼ Accumulated Dep. is a contra asset account that is decreasing . | ||
| Truck | 35,000 | ▼ Truck is an asset account that is decreasing . |
As a result of this journal entry, both account balances related to the discarded truck are now zero.
| Truck | Accumulated Depreciation | |||||||||||
| Date | Item | Debit | Credit | Debit | Credit | Date | Item | Debit | Credit | Debit | Credit | |
| 1/1 | 35,000 | 35,000 | 12/31 | 7,000 | 7,000 | |||||||
| 12/31 | 35,000 | 0 | 12/31 | 7,000 | 14,000 | |||||||
| 12/31 | 7,000 | 21,000 | ||||||||||
| 12/31 | 7,000 | 28,000 | ||||||||||
| 12/31 | 7,000 | 35,000 | ||||||||||
| 12/31 | 35,000 | 0 |
When a fixed asset that does not have a residual value is not fully depreciated, it does have a book value.
The ledgers below show that a truck cost $35,000. Its Accumulated Depreciation credit balance is $28,000. The book value of the truck is $7,000.
Solution
| Truck | Accumulated Depreciation | |||||||||||
| Date | Item | Debit | Credit | Debit | Debit | Date | Item | Debit | Credit | Debit | Credit | |
| 1/1 | 35,000 | 35,000 | 12/31 | 7,000 | 7,000 | |||||||
| 12/31 | 7,000 | 14,000 | ||||||||||
| 12/31 | 7,000 | 21,000 | ||||||||||
| 12/31 | 7,000 | 28,000 | ||||||||||
Discarding a Fixed Asset (Loss)
Compare the book value to what was received for the asset . The truck’s book value is $7,000, but nothing is received for it if it is discarded. If truck is discarded at this point there is a $7,000 loss. Both account balances above must be set to zero to reflect the fact that the company no longer owns the truck. In addition, the loss must be recorded.
To record the transaction, debit Accumulated Depreciation for its $28,000 credit balance and credit Truck for its $35,000 debit balance. Debit Loss on Disposal of Truck for the difference.
| Date | Account | Debit | Credit | ||
| 12/31 | Loss on Disposal of Truck | 7,000 | ▲ Loss is an expense account that is increasing . | ||
| Accumulated Depreciation | 28,000 | ▼ Accumulated Dep. is a contra asset account that is decreasing . | |||
| Truck | 35,000 | ▼ Truck is an asset account that is decreasing . |
Selling a Fixed Asset
A company receives cash when it sells a fixed asset. Take the following steps for the sale of a fixed asset:
- Make any necessary adjusting entry to update the Accumulated Depreciation balance so it is current as of the date of the disposal.
- Calculate the asset’s book value.
- Compare the book value to the amount of cash received. Decide if there is a gain, loss, or if you break even.
- Zero out the fixed asset account by crediting it for its current debit balance.
- Zero out the Accumulated Depreciation account by debiting it for its current credit balance.
- Debit Cash for the amount received.
- Debit Loss on Sale of Asset or credit Gain on Sale of Asset , if necessary.
Selling a Fixed Asset (Breakeven)
A truck that was purchased on 1/1/2010 at a cost of $35,000 has a $28,000 credit balance in Accumulated Depreciation as of 12/31/2013. The truck is sold on 12/31/2013, four years after it was purchased, for $7,000 cash.
Solution Facts
- No additional adjusting entry is necessary since the truck was sold after a full year of depreciation
- Book value is $7,000
- Cash received is $7,000
- Break even – no gain or loss since book value equals the amount of cash received
| Date | Account | Debit | Credit | ||
| 12/31 | Cash | 7,000 | ▲ Cash is an asset account that is increasing . | ||
| Accumulated Depreciation | 28,000 | ▼ Accumulated Dep. is a contra asset account that is decreasing . | |||
| Truck | 35,000 | ▼ Truck is an asset account that is decreasing . |
Selling a Fexed Asset (Loss)
A truck that was purchased on 1/1/2010 at a cost of $35,000 has a $28,000 credit balance in Accumulated Depreciation as of 12/31/2013. The truck is sold on 12/31/2013, four years after it was purchased, for $5,000 cash.
Solution Facts
- No additional adjusting entry is necessary since the truck was sold after a full year of depreciation
- Book value is $7,000
- Cash received is $5,000
- Loss of $2,000 since book value is more than the amount of cash received
| Date | Account | Debit | Credit | ||
| 12/31 | Loss on Sale of Truck | 2,000 | ▲ Loss is an expense account that is increasing . | ||
| Cash | 5,000 | ▲ Cash is an asset account that is increasing . | |||
| Accumulated Depreciation | 28,000 | ▼ Accumulated Dep. is a contra asset account that is decreasing . | |||
| Truck | 35,000 | ▼ Truck is an asset account that is decreasing . |
Selling a Fixed Asset (Gain)
A truck that was purchased on 1/1/2010 at a cost of $35,000 has a $28,000 credit balance in Accumulated Depreciation as of 12/31/2013. The truck is sold on 12/31/2013, four years after it was purchased, for $10,000 cash.
Solution Facts
- No additional adjusting entry is necessary since the truck was sold after a full year of depreciation
- Book value is $7,000
- Cash received is $10,000
- Gain of $3,000 since the amount of cash received is more than the book value
| Date | Account | Debit | Credit | ||
| 12/31 | Cash | 10,000 | ▲ Cash is an asset account that is increasing . | ||
| Accumulated Depreciation | 28,000 | ▼ Accumulated Dep. is a contra asset account that is decreasing . | |||
| Truck | 35,000 | ▼ Truck is an asset account that is decreasing . | |||
| Gain on Sale of Truck | 3,000 | ▲ Gain is a revenue account that is increasing . |
Selling a Fixed Asset (Partial Year)
A truck that was purchased on 1/1/2010 at a cost of $35,000. The truck depreciates at a rate of $7,000 per year and has a $28,000 credit balance in Accumulated Depreciation as of 12/31/2013. The truck is sold on 4/1/2014, four years and three months after it was purchased, for $5,000 cash.
The following adjusting entry updates the Accumulated Depreciation account to its current balance as of 4/1/2014, the date of the sale. Normally the adjusting entry is made only on 12/31 for the full year, but this is an exception since the asset is being sold. It is necessary to know the exact book value as of 4/1/2014, and the accumulated depreciation credit amount is part of the book value calculation.
Journalize the adjusting entry for the additional three months’ depreciation since the last 12/31 adjusting entry. Pro-rate the annual amount by the number of months owned in the year. The amount is $7,000 x 3/12 = $1,750.
| Date | Account | Debit | Credit | ||
| 4/1 | Depreciation Expense | 1,750 | ▲ Depreciation Expense is an expense account that is increasing . | ||
| Accumulated Depreciation | 1,750 | ▲ Accumulated Dep. is a contra asset account that is in creasing . |
| Accumulated depreciation as of 12/31/2013: | Accumulated depreciation as of 4/1/2014: | |||||||||||
| Accumulated Depreciation | Accumulated Depreciation | |||||||||||
| Date | Item | Debit | Credit | Debit | Credit | Date | Item | Debit | Credit | Debit | Credit | |
| 12/31 | 7,000 | 7,000 | 12/31 | 7,000 | 7,000 | |||||||
| 12/31 | 7,000 | 14,000 | 12/31 | 7,000 | 14,000 | |||||||
| 12/31 | 7,000 | 21,000 | 12/31 | 7,000 | 21,000 | |||||||
| 12/31 | 7,000 | 28,000 | 12/31 | 7,000 | 28,000 | |||||||
| 4/1 | 1,750 | 29,750 |
Solution Facts
- Journalize the adjusting entry for the additional three months’ depreciation since the last 12/31 adjusting entry. The amount is $7,000 x 3/12 = $1,750.
- Book value is $5,250 ($35,000 – $29,750)
- Cash received is $5,000
- Loss of $250 since book value is more than the amount of cash received
| Date | Account | Debit | Credit | ||
| 12/31 | Loss on Sale of Truck | 250 | ▲ Loss is an expense account that is increasing . | ||
| Cash | 5,000 | ▲ Cash is an asset account that is increasing . | |||
| Accumulated Depreciation | 29,750 | ▼ Accumulated Dep. is a contra asset account that is decreasing . | |||
| Truck | 35,000 | ▼ Truck is an asset account that is decreasing . |
Partial-year depreciation to update the truck’s book value at the time of sale could also result in a gain or break even situation.
Exchanging/Trading in a Fixed Asset
A company may dispose of a fixed asset by trading it in for a similar asset. This must be supplemented by a cash payment and possibly by a loan. The company receives a trade-in allowance for the old asset that may be applied toward the purchase of the new asset.
The new asset must be paid for. Its cost can be covered by several forms of payment combined, such as a trade-in allowance + cash + a note payable.
Take the following steps for the exchange of a fixed asset:
- Make any necessary adjusting entry to update the Accumulated Depreciation balance so it is current as of the date of the disposal.
- Calculate the asset’s book value.
- Compare the book value to the amount of trade-in allowance received on the old asset. Determine if there is a gain, loss, or if you break even.
- Zero out the fixed asset account by crediting it for its current debit balance.
- Zero out the Accumulated Depreciation account by debiting it for its current credit balance.
- Debit the account for the new fixed asset for its cost.
- Debit Loss on Exchange of Asset or credit Gain on Exchange of Asset , if necessary.
Exchanging a Fixed Asset (Breakeven)
A truck that was purchased on 1/1/2010 at a cost of $35,000 has a $28,000 credit balance in Accumulated Depreciation as of 12/31/2013. The truck is traded in on 12/31/2013, four years after it was purchased, for a new truck that costs $40,000. The company receives a $7,000 trade-in allowance for the old truck. The company pays cash for the remainder.
Solution Facts
- No additional adjusting entry is necessary since the truck was traded in after a full year of depreciation
- Book value is $7,000
- Trade-in allowance is $7,000
- Break even – no gain or loss since book value equals the trade-in allowance
- Cost of the new truck is $40,000. The trade-in allowance of $7,000. The company must pay $33,000 to cover the $40,000 cost.
| Date | Account | Debit | Credit | ||
| 12/31 | Truck (new) | 40,000 | ▲ Truck is an asset account that is increasing . | ||
| Accumulated Depreciation | 28,000 | ▼ Accumulated Dep. is a contra asset account that is decreasing . | |||
| Truck (old) | 35,000 | ▼ Truck is an asset account that is decreasing . | |||
| Cash | 35,000 | ▼ Cash is an asset account that is decreasing . |
Exchanging a Fixed Asset (Break Even with a Loan)
A truck that was purchased on 1/1/2010 at a cost of $35,000 has a $28,000 credit balance in Accumulated Depreciation as of 12/31/2013. The truck is traded in on 12/31/2013, four years after it was purchased, for a new truck that costs $40,000. The company receives a $7,000 trade-in allowance for the old truck. The company pays $20,000 in cash and takes out a loan for the remainder.
Solution Facts
No additional adjusting entry is necessary since the truck was traded in after a full year of depreciation
Book value is $7,000 Trade-in allowance is $7,000
Break even – no gain or loss since book value equals the trade-in allowance
Cost of the new truck is $40,000. The trade-in allowance of $7,000 plus the cash payment of $20,000 covers $27,000 of the cost. The company must take out a loan for $13,000 to cover the $40,000 cost.
| Date | Account | Debit | Credit | ||
| 12/31 | Truck (new) | 40,000 | ▲ Truck is an asset account that is increasing . | ||
| Accumulated Depreciation | 28,000 | ▼ Accumulated Dep. is a contra asset account that is decreasing . | |||
| Truck (old) | 35,000 | ▼ Truck is an asset account that is decreasing . | |||
| Cash | 20,000 | ▼ Cash is an asset account that is decreasing . | |||
| Note Payable | 13,000 | ▲ Note Payable is a liability account that is increasing . |
Exchanging a Fixed Asset (Loss with a Loan)
A truck that was purchased on 1/1/2010 at a cost of $35,000 has a $28,000 credit balance in Accumulated Depreciation as of 12/31/2013. The truck is traded in on 12/31/2013, four years after it was purchased, for a new truck that costs $40,000. The company receives a $5,000 trade-in allowance for the old truck. The company pays $20,000 in cash and takes out a loan for the remainder.
Solution Facts
- No additional adjusting entry is necessary since the truck was traded in after a full year of depreciation
- Book value is $7,000
- Trade-in allowance is $5,000
- Loss of $2,000 since book value is more than the amount of cash received
- Cost of the new truck is $40,000. The trade-in allowance of $5,000 plus the cash payment of $20,000 covers $25,000 of the cost. The company must take out a loan for $15,000 to cover the $40,000 cost.
| Date | Account | Debit | Credit | ||
| 12/31 | Loss on Exchange of Asset | 2,000 | ▲ Loss is an expense account that is increasing . | ||
| Truck (new) | 40,000 | ▲ Truck is an asset account that is increasing . | |||
| Accumulated Depreciation | 28,000 | ▼ Accumulated Dep. is a contra asset account that is decreasing . | |||
| Truck (old) | 35,000 | ▼ Truck is an asset account that is decreasing . | |||
| Cash | 20,000 | ▼ Cash is an asset account that is decreasing . | |||
| Note Payable | 15,000 | ▲ Note Payable is a liability account that is increasing . |
Exchanging a Fixed Asset (Gain with a Loan)
A truck that was purchased on 1/1/2010 at a cost of $35,000 has a $28,000 credit balance in Accumulated Depreciation as of 12/31/2013. The truck is traded in on 12/31/2013, four years after it was purchased, for a new truck that costs $40,000. The company receives a $10,000 trade-in allowance for the old truck. The company pays $20,000 in cash and takes out a loan for the remainder.
Solution Facts
- No additional adjusting entry is necessary since the truck was traded in after a full year of depreciation
- Book value is $7,000
- Trade-in allowance is $10,000
- Gain of $3,000 since the amount of cash received is more than the book value
- Cost of the new truck is $40,000. The trade-in allowance of $10,000 plus the cash payment of $20,000 covers $30,000 of the cost. The company must take out a loan for $10,000 to cover the $40,000 cost.
| Date | Account | Debit | Credit | ||
| 12/31 | Truck (new) | Truck (new) | ▲ Truck is an asset account that is increasing . | ||
| Accumulated Depreciation | 28,000 | ▼ Accumulated Dep. is a contra asset account that is decreasing . | |||
| Truck (old) | 35,000 | ▼ Truck is an asset account that is decreasing . | |||
| Cash | 20,000 | ▼ Cash is an asset account that is decreasing . | |||
| Note Payable | 10,000 | ▲ Note Payable is a liability account that is increasing . | |||
| Gain on Exchange of Asset | 3,000 | ▲ Gain is a revenue account that is increasing . |
Exchanging a Fixed Asset (Partial Year)
A truck that was purchased on 1/1/2010 at a cost of $35,000 has a $28,000 credit balance in Accumulated Depreciation as of 12/31/2013. The truck is traded in on 7/1/2014, four years and six months after it was purchased, for a new truck that costs $40,000. The company receives a $5,000 trade-in allowance for the old truck. The company pays $20,000 in cash and takes out a loan for the remainder.
The following adjusting entry updates the Accumulated Depreciation account to its current balance as of 7/1/2014, the date of the sale. Normally the adjusting entry is made only on 12/31 for the full year, but this is an exception since the asset is being traded in. It is necessary to know the exact book value as of 7/1/2014, and the accumulated depreciation credit amount is part of the book value calculation.
| Date | Account | Debit | Credit | ||
| 7/1 | Depreciation Expense | 3,500 | ▲ Depreciation Expense is an expense account that is increasing . | ||
| Accumulated Depreciation | 3,500 | ▲ Accumulated Dep. is a contra asset account that is in creasing . |
The Accumulated Depreciation credit balance as of 7/1/2014 is $28,000 + $3,500, or $31,500.
Solution Facts
- Journalize the adjusting entry for the additional six months’ depreciation since the last 12/31 adjusting entry. The amount is $7,000 x 6/12 = $3,500.
- Book value is $3,500 ($35,000 – $31,500)
- Trade-in allowance is $5,000
- Gain of $1,500 since the amount of cash received is more than the book value
- Cost of the new truck is $40,000. The trade-in allowance of $5,000 plus the cash payment of $20,000 covers $25,000 of the cost. The company must take out a loan for $15,000 to cover the $40,000 cost.
| Date | Account | Debit | Credit | ||
| 12/31 | Truck (new) | 40,000 | ▲ Truck is an asset account that is increasing . | ||
| Accumulated Depreciation | 31,500 | ▼ Accumulated Dep. is a contra asset account that is decreasing . | |||
| Truck (old) | 35,000 | ▼ Truck is an asset account that is decreasing . | |||
| Cash | 20,000 | ▼ Cash is an asset account that is decreasing . | |||
| Note Payable | 15,000 | ▲ Note Payable is a liability account that is increasing . | |||
| Gain on Exchange of Asset | 1,500 | ▲ Gain is a revenue account that is increasing . |
Partial-year depreciation to update the truck’s book value at the time of trade- in could also result in a loss or break-even situation.