When a non-current asset is sold, there is likely to be a profit or loss on disposal. This is the difference between the net sale price of the asset and its carrying value at the time of disposal.
5.1 The disposal of non-current assets
Non-current assets are not purchased by a business with the intention of reselling them in the normal course of trade. However, they might be sold off at some stage during their life, either when their useful life is over or before then. A business might decide to sell off a non-current asset long before its useful life has ended.
Whenever a business sells something, it will make a profit or a loss. When non-current assets are disposed of, there will be a profit or loss on disposal. As it is a capital item being sold, the profit or loss will be a capital gain or a capital loss. These gains or losses are reported in the income and expenses part of the income statement of the business (not as a trading profit in the trading account). They are
commonly referred to as 'profit on disposal of non-current assets' or 'loss on disposal'.
Examination questions on the disposal of non-current assets are likely to ask for ledger accounts to be prepared, showing the entries in the accounts to record the disposal. But before we look at the ledger accounting for disposing of assets, we had better look at the principles behind calculating the profit (or loss) on disposing of assets.
5.2 The principles behind calculating the profit or loss on disposal
The profit or loss on the disposal of a non-current asset is the difference between (a) and (b) below. (a) The carrying value of the asset at the time of its sale.
(b) Its net sale price, which is the price minus any costs of making the sale.
A profit is made when the sale price exceeds the carrying value, and a loss is made when the sale price is less than the carrying value.
5.3 Example: Disposal of a non-current asset
A business purchased a non-current asset on 1 January 20X1 for $25,000. It had an estimated life of six years and an estimated residual value of $7,000. The asset was eventually sold after three years on 1 January 20X4 to another trader who paid $17,500 for it.
What was the profit or loss on disposal, assuming that the business uses the straight line method for depreciation?
Solution
Annual depreciation = years 6 ,000) 7 _ $(25,000 = $3,000 per annum $ Cost of asset 25,000 Less accumulated depreciation (three years) 9,000 Carrying value at date of disposal 16,000 Sale price 17,500 Profit on disposal 1,500 This profit will be shown in the income statement of the business where it will be an item of other income added to the gross profit brought down from the trading account.5.4 Second example: Disposal of a non-current asset
A business purchased a machine on 1 July 20X1 at a cost of $35,000. The machine had an estimated residual value of $3,000 and a life of eight years. The machine was sold for $18,600 on 31 December 20X4, the last day of the accounting year of the business. To make the sale, the business had to incur dismantling costs and costs of transporting the machine to the buyer's premises. These amounted to $1,200.
The business uses the straight line method of depreciation. What was the profit or loss on disposal of the machine?
Solution
Annual depreciation years 8 3,000) _ $(35,000 = $4,000 per annumIt is assumed that in 20X1 only one-half year's depreciation was charged, because the asset was purchased six months into the year.
$ $ Non-current asset at cost 35,000 Depreciation in 20X1 (½ year) 2,000
20X2, 20X3 and 20X4 12,000
Accumulated depreciation 14,000 Carrying value at date of disposal 21,000 Sale price 18,600
Costs incurred in making the sale (1,200)
Net sale price 17,400 Loss on disposal (3,600) This loss will be shown as an expense in the income statement of the business. It is a capital loss, not a trading loss, and it should not therefore be shown in the trading account.
5.5 The disposal of non-current assets: ledger accounting entries
We have already seen how the profit or loss on disposal of a non-current asset should be computed. A profit on disposal is an item of 'other income' in the income statement, and a loss on disposal is an item of expense in the income statement
It is customary in ledger accounting to record the disposal of non-current assets in a disposal of non- current assets account.
(a) The profit or loss on disposal is the difference between: (i) the sale price of the asset (if any); and
(ii) the carrying value of the asset at the time of sale.
(b) The following items must appear in the disposal of non-current assets account: (i) The value of the asset (at cost, or revalued amount*)
(ii) The accumulated depreciation up to the date of sale (iii) The sale price of the asset
*To simplify the explanation of the rules, we will assume now that the non-current assets disposed of are valued at cost.
(c) The ledger accounting entries are as follows.
(i) DEBIT Disposal of non-current asset account CREDIT Non-current asset account
with the cost of the asset disposed of.
(ii) DEBIT Accumulated depreciation account CREDIT Disposal of non-current asset account
with the accumulated depreciation on the asset as at the date of sale. (iii) DEBIT Receivable account or cash book
CREDIT Disposal of non-current asset account
with the sale price of the asset. The sale is therefore not recorded in a sales account, but in the disposal of non-current asset account itself. You will notice that the effect of these entries is to remove the asset, and its accumulated depreciation, from the statement of financial position.
The balance on the disposal account is the profit or loss on disposal and the corresponding double entry is recorded in the I & E account itself.
5.6 Example: Disposal of assets: Ledger accounting entries
A business has $110,000 worth of machinery at cost. Its policy is to make a provision for depreciation at 20% per annum straight line. The total provision now stands at $70,000. The business sells for $19,000 a machine which it purchased exactly two years ago for $30,000.
Show the relevant ledger entries.
Solution
PLANT AND MACHINERY ACCOUNT
$ $
Balance b/d 110,000 Plant disposals account 30,000
Balance c/d 80,000
110,000 110,000
PLANT AND MACHINERY ACCUMULATED DEPRECIATION
$ $
Plant disposals (20% of $30,000 for 2
years) 12,000 Balance b/d 70,000 Balance c/d 58,000 70,000 70,000 Balance b/d 58,000 PLANT DISPOSALS $ $
Plant and machinery account 30,000 Accumulated depreciation 12,000
I & E a/c (profit on sale) 1,000 Cash 19,000
31,000 31,000
Check
$ Asset at cost 30,000 Accumulated depreciation at time of sale 12,000 Carrying value at time of sale 18,000 Sale price 19,000 Profit on sale 1,000
5.7 Example continued: Part exchange
Taking the example above assume that, instead of the machine being sold for $19,000, it was exchanged for a new machine costing $60,000, a credit of $19,000 being received upon exchange. In other words $19,000 is the trade-in price of the old machine. Now what are the relevant ledger account entries?
Solution
PLANT AND MACHINERY ACCOUNT
$ $
Balance b/d 110,000 Plant disposal 30,000
Cash $(60,000 – 19,000) 41,000 Balance c/d 140,000
Plant disposals 19,000
170,000 170,000
Balance b/d 140,000
The new asset is recorded in the non-current asset account at cost $(41,000 + 19,000) = $60,000.
PLANT AND MACHINERY ACCUMULATED DEPRECIATION
$ $
Plant disposals (20% of $30,000 for
2 years) 12,000 Balance b/d 70,000 Balance c/d 58,000 70,000 70,000 Balance b/d 58,000 PLANT DISPOSALS $ $
Plant and machinery 30,000 Accumulated depreciation 12,000 Profit transferred to I & E 1,000 Plant and machinery-part exchange 19,000
Question
Non-current asset ledger accountsA business purchased two rivet-making machines on 1 January 20X5 at a cost of $15,000 each. Each had an estimated life of five years and a nil residual value. The straight line method of depreciation is used. Owing to an unforeseen slump in market demand for rivets, the business decided to reduce its output of rivets, and switch to making other products instead. On 31 March 20X7, one rivet-making machine was sold (on credit) to a buyer for $8,000.
Later in the year, however, it was decided to abandon production of rivets altogether, and the second machine was sold on 1 December 20X7 for $2,500 cash.
Prepare the machinery account, depreciation of machinery account and disposal of machinery account for the accounting year to 31 December 20X7.
Answer
MACHINERY ACCOUNT
$ $
20X7 20X7
1 Jan Balance b/f 30,000 31 Mar Disposal of machinery
account 15,000 1 Dec Disposal of machinery
account 15,000 30,000 30,000 MACHINERY – ACCUMULATED DEPRECIATION
$ $
20X7 20X7
31 Mar Disposal of
machinery account* 6,750 1 Jan Balance b/f 12,000 1 Dec Disposal of
machinery account** 8,750 31 Dec I & E account*** 3,500 15,500 15,500 * Depreciation at date of disposal = $6,000 + $750
** Depreciation at date of disposal = $6,000 + $2,750 *** Depreciation charge for the year = $750 + $2,750
DISPOSAL OF MACHINERY
20X7 $ 20X7 $
31 Mar Machinery account 15,000 31 Mar Account receivable (sale
price) 8,000 31 Mar Accumulated depreciation 6,750 1 Dec Machinery 15,000 1 Dec Cash (sale price) 2,500 1 Dec Accumulated depreciation 8,750 31 Dec I & E a/c (loss on
disposal) 4,000 30,000 30,000 You should be able to calculate that there was a loss on the first disposal of $250, and on the second disposal of $3,750, giving a total loss of $4,000.
Workings
1 At 1 January 20X7, accumulated depreciation on the machines will be: 2 machines × 2 years ×
5
2 Monthly depreciation is 12 $3,000
= $250 per machine per month 3 The machines are disposed of in 20X7.
(a) On 31 March – after 3 months of the year.
Depreciation for the year on the machine = 3 months × $250 = $750. (b) On 1 December – after 11 months of the year.
Depreciation for the year on the machine = 11 months × $250 = $2,750
5.8 Example: disposal of a revalued asset
Returning to the case of the revalued asset in Sections 4.2 and 4.3, suppose that two years later the land and property is sold for $200,000. What is the profit on disposal?
BUILDING – COST
$ $
Bal b/f 75,000 Disposal account 75,000
BUILDING – ACCUMULATED DEPRECIATION
$ $
Disposal account 6,000 Bal b/f ($2,000 u 2) 6,000
LAND – COST
$ $
Bal b/f 75,000 Disposal account 75,000
REVALUATION RESERVE
$ $
Disposal account 105,000 Bal b/f 105,000
DISPOSAL ACCOUNT
$ $
Building – cost 75,000 Cash 200,000
Land – cost 75,000 Building – acc dep'n 6,000
Profit on disposal 161,000 Revaluation reserve 105,000
311,000 311,000
Ignoring the revaluation:
$ Original cost of building 30,000 Original cost of land 20,000 50,000 Depreciation ($5,000 + $6,000) (11,000) Carrying value 39,000 Sale proceeds 200,000 Profit on sale 161,000