Asset Disposal

What is Asset Disposal?

Asset disposal is removing assets that are no longer needed or beneficial to a company or individual. It is the method of disposing of assets to recover their remaining value or eliminate them from the balance sheet.

Some examples of disposing of an asset are sales, scrapping, or donations. An asset is a company possession that aids in generating profit in daily operations. Assets involved in this process are generally long-term, including heavy machinery, vehicles, or buildings.

When done correctly, the disposal of an asset will result in its removal from its books. This process is called derecognition in accounting. 

Proper removal of an asset is crucial to ensuring accounting records are up to date and standards since assets play a significant part in a company’s evaluation.

Recognizing assets means the asset was recorded on financial statements as an element of use. Therefore, derecognition makes sense as the formal term for removing an item from the financial statements and the overall accounting record. 

There are many ways to dispose of an asset, but a crucial step is properly assigning disposal value. The disposal value is a numeric amount that equates to how much the asset is worth at the date of its deposition.

The disposal value varies on the type of asset and the depreciation method used. But in simple terms, it involved the book value and the accumulated depreciation associated with the asset.

Asset disposal is an essential financial and operational activity for businesses as it allows them to optimize their asset portfolio, recover some of the invested capital, and make room for more valuable or productive assets.

Disposals can also result in gains and losses for the company; we will discuss and work through some examples of this further in the article. For now, it is crucial to understand that the objective of the disposal of an asset is to derecognize a long-term asset in a company's accounting record.

How Does Accounting Play a Role in Asset Disposal?

Accounting plays a crucial role in the disposal of assets by ensuring that the financial impact of the disposal is accurately recorded and reflected in the company's financial statements.

Here's how accounting is involved in asset disposal:

1. Valuation

Accounting determines the value of the assets disposed of. This includes assessing the assets' fair market value or net book value. Depreciation and market conditions play a role in determining both.

There are multiple methods for evaluating assets that we discuss later in the article, but accounting is responsible for ensuring that these assets are valued correctly.

2. Recording Disposal

To record the disposal of an asset, an accountant will use a journal entry or a t account. Then update that transaction to the company's financial records. The asset is removed from the balance sheet, and the corresponding value is adjusted, reflecting the loss or gain.

3. Depreciation Adjustment

If the disposed asset is depreciated, accounting adjusts the depreciation expense accordingly. The remaining depreciation is recognized until the date of disposal, ensuring accurate reporting of the asset's carrying value.

Sometimes assets will lose value over time. Accountants ensure that this loss of value is recorded on the financial statements so that they are upholding the standards of GAAP and not overestimating any numbers.

4. Gain or Loss Recognition

If the disposal of an asset results in a gain, accounting recognizes the gain as income. Conversely, if there is a loss from the disposal, it is recorded as an expense.

5. Financial Statement Impact

The balance sheet must be updated repeatedly to reflect the removal of the assets. The income statement also reflects any gains or losses recognized from the disposal and the impact it has on the net income.

In terms of the financial statements, any losses that are treated like an expense would be debited to decrease the value. Contrary, gains would be credited to reflect the money made from the disposal.

6. Compliance and Disclosures

Accounting must comply with accounting standards, ensuring that regulations and disclosure requirements are met. This includes providing adequate information in the financial statements and any significant risks associated with the disposal.

There can be severe consequences to a company’s operations and reputation if they are found not upholding GAAP standards. Hence, why it is extremely important for companies to dispose of their assets at their correct value.

7. Audit and Internal Controls

Accounting establishes internal controls and procedures to ensure proper authorization and documentation. This helps in conducting audits and ensuring the reliability of financial information related to asset's disposal.

Accounting goes hand in hand with asset disposal because it ensures accuracy in the reports and compliance with applicable regulations and disclosure requirements. 

Overall trustworthy accounting provides reliability in financial reporting, helping stakeholders understand the financial impact of the disposal on the company's performance.

How to Evaluate Asset Disposal

Disposal value is the estimated value of an asset at the time of disposal. It helps organizations determine the financial impact of disposing of an asset and assess its potential returns or losses.

Calculating the disposal value is a crucial step in the disposal of an asset because it can help determine the financial impact the asset will have on the company so they can anticipate a gain or a loss. 

The disposal value is determined based on various factors, such as the market demand for the asset, its condition, age, functionality, and any associated liabilities. 

It’s also typically compared to the asset's book or carrying value to determine whether a gain or loss will be recognized upon disposal.

Evaluating the disposal value of an asset with depreciation will involve more steps than an asset that does not depreciate. To determine what price one should sell their asset for, one must first determine the asset's accumulated depreciation. 

Below are the most common depreciation methods companies use to evaluate the disposal value of plant and equipment.

Straight Line Method

One of the more straightforward approaches, this method assumes the item will depreciate by the same value year by year. Companies use this method because it is relatively easy to calculate.

In this method, you calculate the annual asset depreciation and subtract that same value year by year. It is referred to as simple because you only need to do the calculation once, and the math is fairly easy. 

The formula involves these three components and is shown below:

1. Asset cost: How much the asset was purchased for.
2. Salvage value: How much the asset is worth at disposal time. 
3. Useful life: How long the asset is expected to be helpful to the company. 

The formula for annual asset depreciation is as follows:

Annual asset depreciation = (Asset cost - salvage value) / # years of useful life

Double declining method (Accelerated method)

Double declining is another standard method. This approach recognizes a higher amount of depreciation expense towards the beginning of an asset's life and then gradually reduces that depreciation expense over time.

Since the formula has you dividing the years of useful life by two, the original depreciation expense will be double that of the straight-line method.

A depreciation table is generally used for this calculation because it requires repeated use of the formula dependent on the previous calculations. 

The numbers in the problem are normally given to you or can be found easily on the financial statements.

The formula is as follows:

Annual Asset Depreciation= (Cost - Accumulated Depreciation)* (2/ # Years Of Useful Life) 

Here are some essential things to remember with this method when calculating depreciation:

1. The first year's accumulated depreciation is $0.
2. Depreciation can also be calculated as (2*Straight line depreciation*Book value). 
3. Reflects how some plant and equipment assets lost value quickly in their early years.

The disposal value directly impacts the reported financial results and helps provide a fair view of the company's financial position. 

Additionally, it plays a role in investment decision-making because if companies know how valuable their asset will be as it ages, they can determine if the benefits exceed its costs. 

When considering the purchase of assets, understanding potential disposal value helps determine their net costs. These costs significantly impact financial statements, so carefully choosing assets is extremely important.

Journal Entries of Asset Disposal with Gains

When an asset is disposed of with a gain, the journal entries will involve recognizing the gain and removing the asset from the books. Below is an example of the journal entries for the disposal of assets with a gain.

To record a gain for plant and equipment, they typically all follow this exact format:

Let’s apply this using an example: ABC Company decides to sell a delivery truck they no longer need. The truck was purchased three years ago for $20,000, and its accumulated depreciation is $12,000. The company sells the truck for $15,000 in cash.

Here are the steps to writing this journal entry:

• Debits
  • Since the truck is being sold for $15,000, the company is gaining that 15,000 as a part of its assets; therefore, they will debit cash.
  • Accumulated depreciation is a contra asset. When the accumulated depreciation associated with the truck is sold, disposing of it will require a debit because it is the opposite of its average balance.
• Credits
  • To get rid of the truck, you’ll have to credit it since its standard account is a debit.
  • A $7,000 gain is recognized to balance the accounts and showcase the additional revenue added.

Journal Entries of Asset Disposal with Losses

When an asset is disposed of with a loss, the journal entries will involve recognizing the loss and removing the asset from the books. Below is an example of the journal entries for the disposal of assets with a loss.

To record a loss for plant and equipment, they typically all follow this exact format:

Let’s work through an example now using this logic: XYZ Company decides to dispose of a piece of machinery that is no longer used. The machinery was purchased for $50,000, and its accumulated depreciation is $30,000. 

Unfortunately, the company can only sell the machinery for $15,000 due to its outdated technology.

Here are the steps to writing this journal entry:

• Debits
  • Debit the cash for $15,000 since the company is gaining 15,000 due to their sale.
  • Since accumulated depreciation is a contra asset, we must dispose of it as we did with a gain. Therefore, $30,000 will be debited.
  • A loss is expensed as a debit to represent how much money was lost in the sale.
• Credit
  • It will have to be credited to show you sold the machine on your books since its regular account is a debit.

Journal Entries of Asset Disposal with No Proceeds

When an asset is disposed of with no proceeds, it is abandoned without monetary value. The journal entries involve removing the asset from the books and recognizing any related accumulated depreciation.

In this case, the accumulated depreciation has been used up to its salvage value. In this example, the asset also has no salvage value. An asset having no salvage value is fairly common in accounting.

No salvage value is not always a bad thing, it just means that you have used the asset up to its complete use and you no longer have a purpose for it. We see assets having no value, usually with intangible assets but sometimes with machinery. 

Assets having no salvage value have become increasingly more common in today’s economy since new technology is constantly producing new updates of different equipment, machinery, and tools.

Here's the format for the journal entry with no proceeds:

Let’s work through an example now using this format: XYZ Company decides to dispose of outdated computer equipment that is no longer usable. The computer equipment was initially purchased for $5,000; its accumulated depreciation is $5,000.

Here are the steps to writing this journal entry:

• Debits: Debit the AD for $5,000 since the company no longer needs to record the depreciation associated with that asset.
• Credits:Credit the asset at its historical cost of $5,000 since it is no longer useful.

Researched and authored by Emily Rustom | Linkedin

Free Resources

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