An item of property, plant and equipment can be disposed of in a variety of ways. It may be sold or traded-in against another asset, it could be scrapped, destroyed, stolen, sunk, or seized under a Court Order. Irrespective of how it was disposed, an accountant must:
a) Remove the carrying value from the General Ledger balances as it is no longer an asset of the business. To achieve this, the cost of the asset will be credited to the account in which the cost is recorded and the associated debit will be sent to a Disposals account. Then the accumulated depreciation of the asset will be debited to the appropriate accumulated depreciation account and the corresponding debit will be sent to the Disposals account
b) Record any value received from the disposal, e.g. sale proceeds, trade-in value, insurance proceeds. The value will be credited to the Disposals account and the corresponding debit will be recorded in an account that describes what happened to the disposal proceeds; e.g. if it was banked we would debit the Bank account, if it was used to clear a mortgage it would be debited to a Mortgage account and so on.
When an asset is sold it is likely that the business will make a gain (which could also be called a profit) or a loss on the sale. To calculate this an accountant will compare the disposal proceeds received with the carrying value of the asset at the date of disposal.
- If the disposal proceeds are greater than the carrying value, the business will have made a gain on disposal
- If however, the disposal proceeds are less than the carrying value, the business will have made a loss on disposal
A business has sold its only property for £900,000 with the proceeds being banked. The property cost £750,000 and accumulated depreciation of £125,000 was charged against the asset up to the start of the year. Depreciation for the period from the start of the year to the date of disposal was £25,000.
The accountant would first record the depreciation for the year using the following journal
|Property depreciation expense||£25,000|
|Property accumulated depreciation||£25,000|
The above journal would then be posted to the General Ledger accounts.
The accountant then has the choice of removing the carrying value of the property and then recording the disposal proceeds or could do this in reverse order and record the disposal proceeds first and then remove the carrying value.
In this example we will remove the carrying value first.
Removing the carrying value of the asset
The value of the property is recorded in two ledger accounts; the Property at Cost account and the Property Accumulated Depreciation account. We will therefore record the following two journals:
|Disposal of property||£750,000|
|Property at cost||£750,000|
|Property accumulated depreciation||£150,000|
|Disposal of property||£150,000|
[Note that the accumulated depreciation to be removed is the £125,000 balance at the start of the year plus the depreciation expense of £25,000 for the period up to the disposal date]
The above journals would then be recorded in the ledger accounts.
Recording the disposal proceeds
The money received will be debited to the Bank account and the corresponding credit will be credited to the Disposal of Property account.
|Disposal of property||£900,000|
The journal will be posted to the General Ledger as shown below.
Calculating the gain or loss on disposal
Finally, we can calculate whether a gain or a loss was made on the sale of the property. This can be calculated by closing down the Disposal of Property account which currently records both the carrying value of the property at the date of disposal (as it includes its cost and accumulated depreciation) and the disposal proceeds.
[Note that when a disposal of property account is closed down at the end of an accounting period the balancing figure is sent to the Profit & Loss account and is NOT carried down to the start of the next period.]
The amount sent to the profit and loss account represents either a gain or loss on disposal – but which is it for this example? Well, the asset had a carrying value at disposal of £600,000 and was sold for £900,000 so the £300,000 is a GAIN on disposal.
[Alternatively, if the Profit & Loss entry is recorded on the debit side of the Disposals account it represents a GAIN, if it is recorded on the credit side of the Disposals account it represents a LOSS]
A VAT registered business has sold a machine that originally cost £55,000 and against which accumulated depreciation of £22,500 has been charged. The machine was sold for £20,000 plus VAT with the proceeds being banked.
Journals to remove the carrying value of the asset
|Disposal of machinery||£55,000|
|Machinery at cost||£55,000|
|Machinery accumulated depreciation||£22,500|
|Disposal of machinery||£22,500|
The journals would then be posted to the General Ledger accounts.
Journal to record the disposal proceeds
The gross amount will be deposited in the bank, the VAT on the sale will increase the business’ VAT liability and the net amount will be sent to the Disposals account as shown below.
|Disposal of machinery||£20,000|
The ledger accounts will then be updated for the journal.
Calculating the gain or loss on disposal
The disposal of machinery account can now be closed down and the gain or loss on disposal calculated.
The balance of £12,500 sent to the Profit & loss account represents a LOSS on disposal (as the machine sold had a carrying value of £32,500 (i.e. £55,000 less £22,500) but was sold for only £20,000).