By Yuriy Smirnov Ph.D.
Accounting for asset disposal (also known as derecognition) removes the cost or fair value of a specific asset, related accumulated depreciation, and accumulated impairment losses from the balance sheet. Asset disposal can happen either at the end of the useful life of an asset when it does not generate any further economic benefit or when an asset is sold to a third party.
If disposal proceeds differ from the carrying value of a specific asset, a disposal gain or loss occurs.
There are two basic scenarios of asset derecognition. The first arises when an asset is disposed of without receiving any cash in return. It can happen when an asset is obsolete and there is no secondary market to sell it. In other words, there is no cash flow generated at the end of the asset’s useful life.
The second scenario assumes that an asset is being sold before or at the end of its useful life, which causes a cash inflow. It should be treated in different ways depending on gain or loss resulting from the disposal.
If asset disposal takes place at the end of its useful life and it is fully depreciated, a single entry should be made in the general journal. The debited account is Accumulated Depreciation, and the credited account is the relevant Asset account, e.g., Fixed Assets or Equipment.
Star-X LLC writes off the computer because its useful life has expired and no further economic benefit can be generated. The initial cost of the computer was $2,500, and it was estimated that it had no residual value. As far as the computer is fully depreciated, the entry in the general journal should be as follows:
If an asset is written off before the end of its useful life, i.e., it is not fully depreciated, it should be recorded by debiting Accumulated Depreciation for the whole amount, debiting Loss on Disposal for the difference between the initial cost of an asset and related accumulated depreciation, and crediting the Asset account for its initial cost.
Assume that Star-X LLC decided to write off the computer before its useful life expires. At this date, the accumulated depreciation amounted to $2,000, which means that the carrying amount of the computer is $500, and it should be assigned to loss on disposal.
If an asset is sold for more than its carrying value, a gain on disposal occurs. It should be recorded in the general journal as follows:
Winsdor House Inc. acquired a new machine at a cost of $40,000. Its useful life is estimated as 5 years and its residual value as $5,000. The company uses the straight-line depreciation method and annually prepares financial statements. After 3 years, management sold the machine for $20,000.
To record asset disposal in the general journal, we need to calculate the accumulated depreciation. As the residual value of the machine is $5,000, the depreciable amount is $35,000. The straight-line depreciation method implies that at the end of each year the equal amount will be assigned to depreciation expense, namely $7,000 ($35,000 ÷ 5). After 3 years, accumulated depreciation amounts to $21,000; thus, the carrying amount of the machine will be $19,000. As it was sold at $20,000, a gain on disposal of $1,000 was realized.
If asset disposal proceeds are less than its carrying amount, the loss on disposal is realized, which should be recorded as follows:
Let’s consider Example 3, assuming that the machine was sold for $16,000 instead of $20,000. As the carrying amount exceeds the disposal proceeds, a loss on disposal of $3,000 is realized.
It can happen that disposal proceeds equal an asset’s carrying value, so there is no gain or loss. In this case, the journal entry should look as follows:
Let’s consider Example 3, assuming that the machine was sold to a third party at the end of its useful life for $5,000. Because the carrying amount equals the amount of cash received, no gain or loss is realized.
