When a business disposes of a fixed asset, it may result in a profit or a loss, depending on the difference between the asset’s Net Book Value (NBV) and its selling price. Proper accounting treatment ensures that the gain or loss is recorded correctly in financial statements. This article provides a step-by-step example of how to calculate and account for the profit or loss on disposal of a fixed asset.
1. Scenario: Disposal of Machinery
A company purchases machinery for $80,000 on January 1, 2020. The asset has:
- A useful life of 8 years
- A residual value of $8,000
- A depreciation method of Straight-Line
- After 3 years, the company sells the machine for $55,000
2. Step-by-Step Calculation
Step 1: Calculate Annual Depreciation
Annual Depreciation = (Cost – Residual Value) ÷ Useful Life
= ($80,000 – $8,000) ÷ 8
= $9,000 per year
Step 2: Determine Net Book Value (NBV)
Accumulated Depreciation After 3 Years = 3 × $9,000
= $27,000
Net Book Value (NBV) = Cost – Accumulated Depreciation
= $80,000 – $27,000
= $53,000
Step 3: Compare Selling Price and NBV
- If Selling Price > NBV → Profit
- If Selling Price < NBV → Loss
Selling Price = $55,000
Profit on Disposal = Selling Price – NBV
= $55,000 – $53,000
= $2,000 (Profit)
3. Journal Entry for Profit on Disposal
Debit: Cash $55,000 (Proceeds from sale)
Debit: Accumulated Depreciation $27,000 (Remove accumulated depreciation)
Credit: Machinery Account $80,000 (Remove asset from books)
Credit: Gain on Disposal $2,000 (Recognize profit)
4. Scenario: Disposal at a Loss
If the company sells the machine for $50,000 instead of $55,000:
Loss on Disposal = NBV – Selling Price
= $53,000 – $50,000
= $3,000 (Loss)
5. Journal Entry for Loss on Disposal
Debit: Cash $50,000 (Proceeds from sale)
Debit: Accumulated Depreciation $27,000 (Remove accumulated depreciation)
Debit: Loss on Disposal $3,000 (Recognize loss)
Credit: Machinery Account $80,000 (Remove asset from books)
6. Impact on Financial Statements
A. Balance Sheet
- The asset is removed from the fixed assets section.
- Cash increases from the sale proceeds.
- If a gain occurs, equity increases; if a loss occurs, equity decreases.
B. Income Statement
- A gain is recorded as non-operating income.
- A loss is recorded as an expense, reducing net profit.
C. Cash Flow Statement
- The cash inflow from selling the asset is recorded in investing activities.
- The gain or loss is adjusted in operating activities since depreciation is a non-cash item.
7. Best Practices for Asset Disposal
- Maintain accurate asset records and depreciation schedules.
- Assess market value before disposal to maximize gains.
- Ensure proper authorization and documentation for asset sales.
- Consider tax implications of asset disposal.
Proper Accounting for Fixed Asset Disposal
When a business sells or disposes of a fixed asset, the correct accounting treatment ensures that financial statements reflect the transaction accurately. A profit or loss on disposal occurs based on the difference between the asset’s Net Book Value (NBV) and its selling price. Understanding how to calculate and record the disposal of fixed assets is essential for transparent financial reporting and informed decision-making.