Disposals of non-current assets

A few years ago I wrote a blog about how to account for depreciation using my much loved Mini as an example. Well the bad news is that my Mini recently reached the end of its ‘useful economic life’. That means that it broke down one too many times and had to go to the great big scrapyard in the sky. It was a sad moment for me as it was the first car I had owned from new but one upside was that I managed to sell it for more than I thought it was worth.

Businesses often dispose of assets and need to know how to account for this in their nominal ledger and year-end accounts. It’s an area students often find tricky in their assessments.

First, let’s remind ourselves of the basic transactions used to record the purchase (or acquisition) and the subsequent depreciation of a non-current asset.

Acquisition of a non-current asset

When we buy an asset that is going to be kept for several years, such as a motor vehicle or a machine for the factory (or the factory itself for that matter!) it is known as a non-current (or fixed) asset. The cost of this asset needs to be shown on the balance sheet as it is something that is owned by the business. This process is known as ‘capitalising’ the asset.

The double entry for buying a car for £10,000 would be:

Debit Motor vehicle cost £10,000 (the asset in the Balance Sheet)

Credit Cash £10,000

If the asset has not yet been paid for the credit side of the double entry would be posted to a liability or payables account.

Depreciation of a non-current asset

As time passes the car that we bought will lose value. This loss in value is depreciation and needs to be recognised as the cost of owning and using the asset. If we expect that we will eventually sell our car after 3 years for £1,000 then in total we are going to lose £10,000 – £1,000 = £9,000 in value. This loss in value is the total cost of owning the car which according to the accruals concept needs to be spread over the three years that we thought we were going to own the car for. £9,000/3 = £3,000 per annum. Assuming that the depreciation cost is the same in each year is known as ‘straight line’ depreciation.

The double entry to record this annual depreciation charge in our ledger accounts is:

Debit Depreciation charge £3,000 (this is an expense in the P&L)

Credit Motor vehicle accumulated depreciation £3,000 (which is offset against the debit in the cost account to give the Net Book Value of the asset)

After two years of owning the asset we would have posted this double entry twice and would therefore have a total balance of £6,000 in the accumulated depreciation account leaving a Net Book Value of £10,000 – £6,000 = £4,000. The accumulated depreciation account builds up each year that we own the asset.

Disposal of a non-current asset

Let’s say that at the start of the third year we sell the car for £2,500. When we dispose of an asset we use a ledger account called the Disposal account to record the transaction and work out if we have made a profit or loss on disposal.

I like to think of this as a three step process:

  1. As we no longer own the asset we need to remove the original cost from the balance sheet. Since the cost was set up as a debit balance we need to credit it to eliminate it. We post the debit to the Disposals account:

Debit Disposals £10,000

Credit Motor vehicle cost £10,000

  1. As we are removing the cost from the balance sheet we also need to remove the accumulated depreciation (since this was linked to the cost). The accumulated depreciation is a credit balance so we need to post a debit to remove it. The credit entry goes to the Disposals account:

Debit Motor vehicle accumulated depreciation £6,000 (remember we had posted to this account in both the first and second years)

Credit Disposals £6,000

At this stage the Disposals account contains a debit of £10,000 and a credit of £6,000 meaning that it effectively contains the Net Book Value of the asset of £4,000.

  1. We now post the proceeds of disposing of the asset to the Disposals account. As the cash received will be a debit to the cash account we credit the Disposals account:

Debit Cash £2,500

Credit Disposals £2,500

This gives us a third entry in the Disposals account which now looks like this:

                                                          Disposals                                                                        

 Dr                                                                                                                                                              Cr
Narrative £     Narrative £  
1.Motor vehicle cost 10,000 2. Accumulated Depreciation 6,000
3. Cash 2,500
 .  .  .  .  .
 .  .  .  .  .

 

To work out the profit or loss on disposal we compare the Net Book Value (this is what the asset is worth in the accounts) to the proceeds generated from the disposal.

Our car had a NBV of £4,000 when we sold it but we only received £2,500. Selling an asset for less than NBV gives a loss on disposal, in this case of £1,500. If we had managed to sell the asset for £5,000 we would have made a profit on disposal of £1,000.

The other way to work this out is just to balance of the Disposals account as follows:

                                                                          Disposals                                                                   
Dr                                                                                                                                                              Cr
Narrative £     Narrative £  
1.Motor vehicle cost 10,000 2. Accumulated Depreciation 6,000
3. Cash 2,500
Loss on disposal (Bal Fig) 1,500
10,000 10,000

 

The fact that the balancing figure is on the credit side of the Disposals account means that we would need a debit in the P&L to complete the double entry. This proves that it is indeed a ‘loss’ on disposal as a debit in the P&L reduces profit for the period.

 

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