When a business disposes of a fixed asset, it may result in either a profit or a loss, depending on the difference between the asset’s net book value (NBV) and its selling price. The gain or loss on disposal is recorded in the financial statements and affects net income. This article explores how businesses calculate and account for profit or loss on disposal, including journal entries and examples.
1. Understanding Profit or Loss on Disposal
A. Profit on Disposal
A profit occurs when an asset is sold for more than its net book value.
Formula:
Profit on Disposal = Selling Price – Net Book Value
B. Loss on Disposal
A loss occurs when an asset is sold for less than its net book value.
Formula:
Loss on Disposal = Net Book Value – Selling Price
2. Steps for Calculating Profit or Loss on Disposal
Step 1: Determine Net Book Value (NBV)
The NBV of an asset is calculated as:
Net Book Value = Cost of Asset – Accumulated Depreciation
Step 2: Compare Selling Price with NBV
- If Selling Price > NBV → Profit
- If Selling Price < NBV → Loss
Step 3: Record Journal Entries
The sale of a fixed asset requires accounting for:
- Removing the asset from the books.
- Recording accumulated depreciation.
- Recognizing any profit or loss.
3. Example of Profit on Disposal
Scenario:
- A company purchases a vehicle for $50,000.
- The estimated useful life is 5 years.
- Depreciation is recorded using the Straight-Line Method.
- After 3 years, the vehicle is sold for $25,000.
Step 1: Calculate Net Book Value
Annual Depreciation = Cost ÷ Useful Life
= $50,000 ÷ 5
= $10,000 per year
After 3 years:
Accumulated Depreciation = 3 × $10,000 = $30,000
Net Book Value = Cost – Accumulated Depreciation
= $50,000 – $30,000 = $20,000
Step 2: Compare Selling Price with NBV
Profit on Disposal = Selling Price – NBV
= $25,000 – $20,000 = $5,000
Step 3: Journal Entry for Profit
Debit: Cash $25,000
Debit: Accumulated Depreciation $30,000
Credit: Vehicle Account $50,000
Credit: Gain on Disposal $5,000
4. Example of Loss on Disposal
Scenario:
- The same vehicle is sold for $15,000 instead of $25,000.
Step 1: Calculate Loss
Loss on Disposal = NBV – Selling Price
= $20,000 – $15,000 = $5,000
Step 2: Journal Entry for Loss
Debit: Cash $15,000
Debit: Accumulated Depreciation $30,000
Debit: Loss on Disposal $5,000
Credit: Vehicle Account $50,000
5. Impact on Financial Statements
A. Balance Sheet
- The fixed asset is removed from the books.
- Cash or accounts receivable increases from the sale.
B. Income Statement
- A gain increases net income.
- A loss decreases net income.
C. Cash Flow Statement
- The sale proceeds appear under investing activities.
- The gain or loss is adjusted in the operating activities section.
6. Tax Implications of Disposal
- Gains on disposal may be subject to capital gains tax.
- Losses may be deductible against taxable income.
- Some jurisdictions provide tax relief for reinvesting in new assets.
7. Best Practices for Asset Disposal
- Assess the market value before selling.
- Ensure proper approval and documentation of asset disposals.
- Consider reusing or repurposing assets before disposal.
- Comply with tax regulations related to asset sales.
Properly Accounting for Fixed Asset Disposal
Disposing of fixed assets requires careful calculation of profit or loss to ensure accurate financial reporting. Businesses must compare the asset’s net book value with its selling price and record any gains or losses in the financial statements. Understanding the correct accounting treatment helps businesses manage their assets efficiently and maintain transparency in financial reporting.