The disposal of an asset

Step one

So, if you have an asset which you have held for a number of years, there will be two things attached to that asset; an original cost, and some accumulated depreciation. When the asset is sold, both of these need to be removed.

The original purchase of the asset would have been to debit the asset account and credit the bank (assuming it was paid in cash), or credit the purchase ledger control account if it was paid on credit. Either way, we have debited the asset cost account. If the asset has gone, we need to get rid of this asset.  So to remove an asset, which is a debit, we need to enter a credit.  If the asset was bought for £10,000, we would credit the cost account with £10,000 to remove all trace of the cost of this asset.

Now in accountancy, the number one rule is that there must be an equal and opposite debit and credit for every transaction.  So here we have a credit to the cost account, so we need a debit, “because they are the rules”.  So just put the debit to the disposals account, don’t overly worry why, you do it, so everything balances.  Now that is the cost dealt with, and our disposals account would look like this (the narrative in the account is the name of where the other side of the transaction is, so you can trace the transactions through the ledger):

Step two

The next step is the accumulated depreciation. Accumulated depreciation is a provision we have entered into account accounts to offset the cost of the asset, to reflect the fall in value of the asset as it is used over time.  The cost was a debit, so to reduce the value off this we need to enter a credit.  We don’t enter a credit to the cost account, but we enter a credit to a provision known as the accumulated depreciation account.  The net figure of both the cost and accumulated depreciation account is known as the net book value, or NBV.

Just like with the cost we need to remove all trace of the asset including the accumulated depreciation.  The accumulated depreciation will be a credit, so to reduce it, we need to enter a debit.  The balancing credit goes to the disposals account.  So if the asset had accumulated depreciation of £3,000, we would debit the accumulated depreciation account with £3,000 and credit the disposals account with £3,000.

So now our disposals account would look like this:

Step three

Unless we are scrapping the asset, we will receive something for the asset. This could be either money or it could be a part exchange allowance towards a new asset we are buying.

The most straight forward transaction is where we receive money for the asset we are selling. The double entry is to debit the bank (as we are increasing the amount of money in the bank account), and then the other transaction must be a credit in the disposals account, as everything has to balance.

However, if you are trading in the old asset against the cost of the cost of a new asset, you will only actually pay the difference between the values of the two. So we are in effect, receiving part of the new asset for the old asset.

Instead of receiving money, we receive part of a new asset, so we debit the asset account with the value of the part of the new asset we are receiving as the part exchange allowance. We then credit the disposals account, as again, everything has to balance.

So, if in our example, we receive a part exchange allowance of £5,000 against a new piece of machinery, we would debit the new machinery cost account with £5,000 and then credit the disposals account with £5,000.

So our disposals account would look like this:

Step four

The next step is to balance it off. We can see that the debit side is greater than that credit side.  This means we have made a loss on disposal, as we need to credit the disposals account to balance it off.  This means the other side of the balancing figure is a debit, remember a debit would increase an expense.  If the balancing figure in the disposals account had been a debit that would mean the other side must have been a credit, which would reduce an expense.  We can check this manually, if the cost was £10,000, and the provision for depreciation was £3,000, the NBV would have been £7,000.  However, we only received £5,000, so we have made a £2,000 loss on disposal, as we have received less than the asset was held for.

The balanced off disposals account would look like this:

Question

Why don’t you have a go at the following example? Remember if you use the disposal account, the loss or profit on disposal should just “pop” out.

An asset which originally cost £20,000, had been depreciated at £2,000 per year, for three years was sold for £15,000.

You can see me work out the answer below: