What is fixed assets disposal and how to record it?
What does fixed assets’ disposal mean? Depreciation of fixed assets In which cases do we proceed with fixed assets’ disposal? How to record the disposal of the fixed assets? Example of fixed asset disposal Key takeaway
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), or 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.
Don’t worry! In this article, we will explain what fixed assets’ disposal means, in which case you have to proceed with fixed assets’ disposal, how to record it, and some examples.
What does fixed assets’ disposal mean?
The fixed assets’ disposal is defined as the removal of a fixed asset from the assets of a company. The disposal of a fixed asset is an extraordinary transaction, that is to say an unusual one. The disposal price is therefore an exceptional product.
From a business standpoint, a fixed assets’ disposal then involves studying the extent of the changes in the company's assets. But it is also asking that the impact of this sale on the company's accounts be taken into account. From an accounting standpoint, the disposal of fixed assets, therefore, takes place in three stages:
- the withdrawal of assets,
- the collection of the amount,
- the taking into account the asset gain or loss.
Reminder: What are fixed assets?
Fixed assets designate assets that form part of the company's assets and which are intended to remain there in the medium or long term. They are thus distinguished from consumable assets. Fixed assets are part of the company's investments.
There are 3 main types of fixed assets:
- tangible fixed assets (immovable and movable property),
- intangible assets (brands, patents, licenses, software, etc.),
- financial assets (equity investments, investment funds, loans granted by the company, etc.).
Depreciation of fixed assets
If you can sell a fixed asset, it is because it has a value that is usually not its original purchase value. For business accounting, the value of a fixed asset decreases over time in a linear fashion. Depreciation is calculated taking into account the expected duration of use of the asset.
We then talk about depreciation to refer to the depreciation of the asset over the years. At all times, to take this depreciation into account, the company records depreciation. This makes it possible to calculate the value of an asset at any time, it is its net book value (NAV). In a way, this is the remaining value of the asset concerned at a time T.
NAV = Acquisition value of an asset - All past depreciation
For example, a production tool is purchased for $10,000 and must participate in the activity of the company for a period of 10 years. Each year, the company then passes a depreciation allowance of $1,000. After five years, the net book value of the tool is $5,000, i.e. $ 10,000 - (5 x $1,000). After 10 years of use, while the tool is considered obsolete, its value is zero.
It is important to note that the net book value of an asset, whether tangible, intangible, or financial, has no relation to its market value. Thus, a perfectly depreciated machine can be considered obsolete and without little value in the production tool of the company, but still have a significant market value in the second-hand resale market, as long as it interests another actor. Conversely, an object can lose a large part of its market value when it is used, without this modifying the linear principle of depreciation.
In which cases do we proceed with fixed assets’ disposal?
The fixed asset disposal is an extraordinary transaction, in the sense that it does not enter into the usual production cycle. Any amounts collected in connection with the disposal of an asset, therefore, constitute an exceptional income for the company. The cases that involve disposing of fixed assets are generally as follows:
- The replacement of fixed assets, in particular within the framework of the renewal of instruments,
- The search for a financial capital gain during the transaction, for example for the sale of equity securities or real estate,
- Normal development in the activity of the company, which adapts its production system to changes in the market and to the needs of its customers.
The disposal of fixed assets can then take several forms:
- The sale of fixed assets,
- An exchange of assets, particularly financial assets,
- Destruction or disposal of fixed assets. The latter may be voluntary or the result of an event beyond the control of the company. In the latter case, it can be considered an assignment, provided that the destruction has not been compensated by insurance.
How to record the disposal of the fixed assets?
From an accounting point of view, a disposal of a fixed asset gives rise to 2 distinct transactions: the withdrawal of the assets of the asset and the collection of the sale price.
Withdrawal of the assets
In the event of a sale, the fixed assets that have been sold must cease to be included in the assets of the company. This is an absolutely essential step. During the sale, a first accounting movement is made. The assets of the company must be reduced by the amount of the fixed asset that has been sold.
This amount is that of the net book value, therefore taking depreciation into account. If the asset is not depreciable, the value removed from the assets of the company is then the acquisition value.
Fact: in the event of non-depreciable fixed assets, the acquisition value is taken into account.
Collection of the sale price
When the net book value is taken out of the portfolio, the amount of the receipt of the eventual sale is entered into the company's account lines. The disposal therefore simultaneously entails an exit and an entry in the balance sheet but in different lines. For the company, this collection is an exceptional product. It must appear as such in the income statement of the balance sheet.
Capital gain, loss: the impact of the disposal of the fixed assets on the company's accounts
The difference between the exit from the assets and the receipt of the sale price in the disposal of the fixed assets will determine whether the fact of disposing of fixed assets allowed the company to make a profit or on the contrary a loss. This is referred to as a capital gain or loss realized by the company during the sale:
- In the event of destruction or disposal, there is a loss.
- In the event of a sale, if the amount of the sale is greater than the net book value, then the business has made an asset gain.
In other words, if the difference between the sale price and the net book value of the fixed asset disposal is positive, the company has obtained an asset gain. If this difference is negative, the company suffers a loss. If the market value of the fixed asset is equal to or less than its book value, it is always possible to limit the loss as much as possible.
Example of fixed asset disposal
To help you understand how to make the disposal of a fixed asset, we take an example of a company that purchases equipment for $20,000 and recognizes $1,000 of depreciation per year over the following five years during the asset’s life. At that time, the equipment is not only fully depreciated. That company donates the machine for free.
|Accumulated depreciation expense||$20,000|
|The article cost||$20,000|
A case that can happen is to write off a fixed asset. In this case, write off the part of the asset that has not been depreciated to a loss account. The company donated the machine for free after two years when the equipment didn’t depreciate $18,000 of the asset's first $20,000 cost. We record all in the disposal journal entry following:
|Loss of disposal||$18,000|
|Accumulated depreciation expense - articles||$2,000|
|The article cost||$20,000|
We take the same example, but here is an example when the company creates a capital gain.
The company bought equipment for $20,000. The depreciation of the asset is $1,000 per year. Actual proceeds from the sale of the used asset turned out to be $17,000.
So here we have the sale proceeds exceed the carrying amount = ($17,000 − ($20,000 - 5 × $1,000)) = $2,000. This is what the company has gained.
|Accumulated depreciation - article||$1,000|
|The article cost||$20,000|
|Gain of disposal||$2,000|
In conclusion, a company can make fixed asset disposal for different reasons. This exceptional transaction gives rise to the accounting recording of a decrease in the assets of the value of this fixed asset and the collection of the sale price, showing a gain or a loss. Good management of disposals, whether they are scrapping or sales, can help minimize losses and even make some profits. By choosing the right time to carry out a resale, or even by optimizing the management of obsolescence, we see that the disposal of fixed assets can be a profitability lever for the company.