Disposal of Operating Assets: Explanation
When accounting for the disposal of operating assets, the firm should record a gain or loss for the difference between the net salvage proceeds and the asset’s book value as of the disposal date.
It should be noted that any gain or loss from disposing of an asset is only an adjustment to income caused by inaccurate estimates of salvage value or service life.
To measure the gain or loss and operating income, the book value should be adjusted by the partial year’s depreciation expense prior to recording the disposal.
For example, consider this asset:
The book value as of 31 December 20×3 is computed under the half-year convention for partial year’s depreciation as follows:
The following journal entry would be made to record the depreciation for the first half of 20×4 (one-half year’s depreciation):
In addition, the journal entry below would be made to record the disposal (note that the amount of accumulated depreciation is the sum of $52,500 and $10,500).
In practice, these two journal entries are likely to be combined.
The net gain or loss on all disposals should appear separately in the income statement only if the amount is material. If the disposal removes a significant segment of operating capacity, it should be reported as a discontinued operation.
The SCFP should identify the amount of working capital provided by disposals ($35,000 for the example above) and should adjust the income figure for any gains or losses to present the amount of working capital provided by operating activities alone.
If the seller accepts a note receivable from the buyer, the realistic interest rate should be used to determine the selling price of the asset. If the seller accepts another asset in exchange, there may or may not be a gain or loss on the exchange.
If the disposal occurs as a result of a casualty, such as theft, fire, or storm damage, the cash settlement received from insurance is added to the proceeds.