Disposals: What Happens When We Sell PPE?

Wow – you’ve done a lot of work on PPE! You know how to account for purchases and how to value PPE over time. That’s no small feat!

Of course, companies don’t keep their assets forever. At some point companies will dispose of assets. What is a disposal? It may mean taking a broken or worn asset to the garbage dump. Or it may mean selling an asset to another company. In either case, the company no longer has possession of the asset after disposal. Pretty straightforward: the company owns the asset until they dispose of it.

Now that you have the concept – the company used to own an asset, now they don’t – let’s take a look at the accounting. When a company disposes of an asset, we have to think about three things:

Proceeds:

how much is the company getting for the asset? This amount may be zero.

De-recognition of the PPE Accounts:

we have to get the PPE and any accumulated depreciation off the Statement of Financial Position. This makes sense because the company no longer controls the disposed PPE, so it doesn’t meet the definition of an asset.

Gain or Loss:

calculated as proceeds – NBV of the PPE asset. If proceeds is higher than the NBV of the asset, we have a gain; if proceeds is lower than NBV, we have a loss. You saw these gains and losses in Chapter 4. They belong on the Income Statement in the section called other income and expenses; gains and losses.

On the other hand, peripheral activities are necessary to business functioning but occur outside the business model. Examples of peripheral items are interest income and expenses, and gains and losses on disposal of assets. That is, unless you are doing accounting for a real estate company with a business model of creating value from buying real estate assets and selling them for a higher price (flipping houses, for example), all purchases and sales of PPE are peripheral activities.

Now to the fun part. Let’s look at how the financial statements change when we dispose of an asset through an example.

My Turn:

Java Great Day Inc. (JGD) purchased a cutting-edge commercial espresso machine to increase efficiency and keep up with customer demand during peak operating hours. The old machine is still operational and has been sold to a competitor for cash of $5,500. Here’s some information about the old machine:

• The old machine was purchased 15 July 20X0 and sold 05 February 20X4.
• It has a useful life of 7 years. No residual value was expected at the end of its useful life.
• The cost of the old machine was $10,000 and it has been depreciated using the straight-line method.
• The company has a policy of taking half a year’s depreciation in the year of purchase and disposal.

Required:

Prepare a journal entry to record disposal of the old espresso machine on 05 February 20X4.

What does the Company Receive in Proceeds?

JGD received $5,500 cash for the old machine.

What is the net book value (NBV) of the old machine on the Statement of Financial Position?

Cost	10,000
Accumulated Depreciation	(5,714)	Accumulated Depreciation: Calculation: $10,000 × 4⁄7
Net Book Value	4,286

Calculate the gain (loss) as proceeds less NBV.

Proceeds	5,500
NBV	(4,286)
Gain (Loss) on Sale	1,214

Journal Entry:

05 February 20X4:

(to record sale of old espresso machine)

DR		Cash	5,500
	CR	Equipment (espresso machine)		10,000
DR		Accumulated Depreciation — Equipment	5,714
	CR	Gain on sale of equipment		1,214

Great work! What will the cost and accumulated depreciation of the equipment be on the Statement of Financial Position after your journal entry?

All balances related to the old espresso machine have been de-recognized. This is appropriate because JGD no longer owns and controls the old espresso machine. Ownership has transferred to the purchaser: the espresso machine is now owned and controlled by JGD’s competitor.

JGD will show a gain on sale of equipment on its Income Statement under the heading “other income/expenses; gains and losses”. The gain will increase income. Assuming that JGD has a December 31 fiscal year end, the gain on sale will be presented like this:

Very nice! Before we move on to your turn, let’s look at a case where proceeds is zero. How would we account for the sale of the espresso machine if it was broken and unrepairable?

My Turn:

Java Great Day Inc. (JGD) purchased a cutting-edge commercial espresso machine to increase efficiency and keep up with customer demand during peak operating hours. The old machine is broken beyond repair and discarded as trash. Here’s some information about the old machine:

• The old machine was purchased 15 July 20X0 and sold 05 February 20X4.
• It has a useful life of 7 years.
• The cost of the old machine was $10,000 and it has been depreciated using the straight-line method.
• The company has a policy of taking half a year’s depreciation in the year of purchase and disposal.

Required:

Prepare a journal entry to record disposal of the old espresso machine on 05 February 20X4.

What does the Company Receive in Proceeds?

JGD received $0 for the old machine.

What is the net book value (NBV) of the old machine on the Statement of Financial Position?

Cost	10,000
Accumulated Depreciation	(5,714)	Accumulated Depreciation: Calculation: $10,000 × 4⁄7
Net Book Value	4,286

Calculate the gain (loss) as proceeds less NBV.

Proceeds	5,500
NBV	(4,286)
Gain (Loss) on Sale	(4,286)

Journal Entry:

05 February 20X4:

(to record sale of old espresso machine)
lines with $0 adjustments would ordinarily be deleted – shown for illustrative purposes

DR		Cash	5,500
	CR	Equipment (espresso machine)		10,000
DR		Accumulated Depreciation — Equipment	5,714
DR		Loss on disposal of equipment	4,286

Appropriately, the Statement of Financial Position will no longer show balances for the old espresso machine. The Income Statement will show a loss on disposal of equipment. The equipment wasn’t sold in this example, it was junk. So we can’t call the Income Statement item a “loss on sale”. Instead we call it a “loss on disposal”. The loss will decrease income be presented like this: