Disposal of a Non-Current Depreciable Asset

Overview

The disposal of a non-current asset involves removing it from the business’s records. This process includes accounting for the asset’s carrying value, proceeds from the disposal (if any), and any resulting profit or loss.

KEY TAKEAWAY: Disposal of a non-current asset is a relatively rare event compared to sales of inventory, but must be accurately recorded when it occurs.

Reasons for Disposal

• Age and wear: Assets become less efficient or obsolete over time.
• Technological advancements: Newer, more efficient assets may become available.
• Change in business strategy: An asset may no longer align with the business’s strategic goals.

Steps in Recording Disposal

1. Calculate Accumulated Depreciation: Determine the total depreciation expense recorded for the asset up to the date of disposal.
2. Calculate Carrying Value:
   • Carrying Value = Cost - Accumulated Depreciation
3. Record the Disposal: This involves several entries in the general journal:
   • Remove the asset’s original cost from the asset account.
   • Remove the accumulated depreciation from the accumulated depreciation account.
   • Record any cash received from the sale.
   • Calculate and record any profit or loss on disposal.

Accounting Entries

General Journal Entries

• Debit:
  • Cash (if the asset is sold for cash)
  • Accumulated Depreciation
  • Loss on Disposal (if applicable)
• Credit:
  • Asset Account (original cost)
  • Profit on Disposal (if applicable)

Example

Assume a vehicle with an original cost of \$50,000 and accumulated depreciation of \$30,000 is sold for \$25,000 cash.

1. Carrying Value: \$50,000 - \$30,000 = \$20,000
2. Profit/Loss: \$25,000 (Proceeds) - \$20,000 (Carrying Value) = \$5,000 (Profit)

General Journal Entry:

EXAM TIP: Always ensure your debits equal your credits in the general journal entry.

Profit or Loss on Disposal

Calculating Profit or Loss

• Profit on Disposal = Proceeds from Sale - Carrying Value
• Loss on Disposal = Carrying Value - Proceeds from Sale

Reasons for Profit or Loss

• Profit: The asset was over-depreciated. The proceeds exceed its carrying value.
• Loss: The asset was under-depreciated. The proceeds are less than its carrying value.

Impact on Financial Statements

• Income Statement: Profit or loss on disposal is reported as a separate line item, often under “Other Income” or “Other Expenses.”
• Cash Flow Statement: The cash received from the sale is reported as an investing cash inflow.

COMMON MISTAKE: Forgetting to remove both the asset’s cost and accumulated depreciation from the general ledger.

Trade-In of a Non-Current Asset

Overview

A trade-in occurs when an existing asset is exchanged for a new asset, with the trade-in value reducing the cost of the new asset.

Recording a Trade-In

1. Determine the trade-in value.
2. Calculate any profit or loss on disposal of the old asset (Trade-in value - Carrying Value).
3. Record the acquisition of the new asset at its cash price.
4. Adjust for the trade-in:
   • Reduce the cash paid by the trade-in value.

Example

A business trades in an old machine with a carrying value of \$15,000 for a new machine with a cash price of \$40,000. The trade-in value offered for the old machine is \$18,000.

1. Profit on Disposal: \$18,000 - \$15,000 = \$3,000
2. Cash Paid: \$40,000 - \$18,000 = \$22,000

General Journal Entries:

STUDY HINT: Practice journal entries for both cash sales and trade-ins to reinforce your understanding. Use varied scenarios with profits and losses.

Reporting in Financial Statements

Income Statement

The profit or loss on the disposal of a non-current asset is reported in the income statement. This impacts the business’s overall profitability.

Balance Sheet

The non-current asset and its associated accumulated depreciation are removed from the balance sheet upon disposal. The new asset purchased (if applicable) is recorded.

Cash Flow Statement

The cash flow associated with the disposal (i.e., cash received from the sale) is reported in the investing activities section.

APPLICATION: Understanding the disposal of non-current assets helps businesses make informed decisions about asset replacement and investment strategies.

Key Terms

• Carrying Value: The cost of an asset less accumulated depreciation.
• Proceeds on Disposal: The revenue received from selling an asset.
• Profit on Disposal: Occurs when the proceeds exceed the carrying value. This is because it has been over-depreciated.
• Loss on Disposal: Occurs when the carrying value exceeds the proceeds. This is because it has been under-depreciated.
• Trade-in: Exchanging an existing asset for a new asset, with the trade-in value reducing the cost of the new asset.
• Over-depreciation: When an asset has been depreciated too much, resulting in its carrying value being lower than its actual market value.
• Under-depreciation: When an asset has not been depreciated enough, resulting in its carrying value being higher than its actual market value.

VCAA FOCUS: Expect questions on calculating profit or loss on disposal, preparing journal entries, and explaining the impact of disposal on financial statements.