During its activity, it is not uncommon for a company to proceed with fixed asset disposal, either to replace it (example: renewal of equipment that has become obsolete), to obtain an asset gain (example: securities participatory), or due to normal changes in its activity.
From an accounting point of view, it is then a question of noting all the changes in the assets of the company, as well as the impact on the income statement of the fixed assets’ disposal operation.
Asset Disposal Definition
Asset disposal is the act of selling an asset usually a long-term asset that has been depreciated over its useful life-like production equipment.
The disposal of assets involves eliminating assets from the accounting records. This is needed to completely remove all traces of an asset from the balance sheet (known as derecognition). Asset disposal may require the recording of a gain or loss on the transaction in the reporting period when the disposal occurs. For the purposes of this discussion, we will assume that the asset being disposed of is a fixed asset.
The overall concept for accounting for asset disposals is to reverse both the recorded cost of the fixed asset and the corresponding amount of accumulated depreciation. Any remaining difference between the two is recognized as either a gain or a loss. The gain or loss is calculated as the net disposal proceeds, minus the asset’s carrying value.
Disposal of Assets Explanation
According to its depreciation, many companies contain an asset disposal policy to replace equipment. When companies sell this equipment it gains a salvage value or residual value which can be a gain or a loss per the books. You must submit his gain or loss for disposal assets accounting on the income statement as a part of net income. It should also be noted that the company will need to reduce the amount of value left with the asset if it was not reduced to zero per depreciation.
How an Asset Disposal Plan Works
An asset disposal plan is an essential component of a sound asset management plan because the disposal of assets accounts for a significant part of the full life-cycle costs of an asset. Asset disposal includes any activity associated with the disposal of a decommissioned asset, such as its sale, demolition, or relocation.
The International Infrastructure Management Manual recommends that an asset disposal plan should include forecasts of the timing for future asset disposals and cash flow forecasts identifying income and expenditures associated with asset disposal.
Well-managed asset disposal reduces asset management costs, provides superior services to the community, and ensures a lower tax burden for taxpayers.
Essential Components of an Asset Disposal Plan
An asset disposal plan should show a timeline whereby replacement assets are operational and ready to absorb the workload of the decommissioned asset. That way, users are not inconvenienced, and operations can continue without interruption.
Disposal costs are expenses that are directly related to asset disposal. The costs can be significant because of the difficulty associated with the disposal of infrastructure assets. Income and expenses associated with asset disposal are dependent on whether the assets are sold, demolished, or relocated.
Accounting for Asset Disposal
Accounting for asset disposal is pretty simple. You only have to close the corresponding asset accounts and contra-asset accounts.
For example, you have a piece of fully-depreciated equipment. Since it is already depreciated, you decide to dispose of it. In the above case, the accounts that we’ll have to close are the Equipment asset account, and the Accumulated Depreciation – Equipment contra-asset account.
Since an asset account normally has a debit balance, we need to credit it to close it out. On the other hand, a contra-asset account normally has a credit account. As such, we need to debit it to close it.
Why do companies perform asset disposal?
Companies dispose of their assets for a variety of reasons, including:
- The asset’s value has fully depreciated: Many companies decide to replace assets at the end of their useful life. Exchanging old assets for new ones can help a company improve productivity because newer assets are likely more efficient.
- The asset is no longer useful: Companies often replace assets that are no longer useful. For example, if a company creates a new automated process for its production line, the machines that required operators are no longer useful.
- Unforeseen circumstances: Sometimes companies experience unforeseen circumstances, such as asset theft. They record these instances as disposals.
- Asset replacement: As technology develops, so do assets. Some companies replace outdated assets with ones that have more modern technology.
- Repair costs exceed an asset’s value: Maintenance costs might increase as an asset gets older, which can cause expenses to exceed the asset’s current value. Companies may decide to replace machinery or equipment when these costs exceed the profits generated from the asset.