First important thing to understand is that the tern fixed asset or non-current assets are such resources of assets which are not bought or sold as main activity of the business and are distinct from stock or inventory. Therefore sale or purchase of fixed asset in accounting perspective is NOT same as sale or purchase of inventory. Inventory is such asset that is bought with an intention to sell. Whereas other assets are bought with an intention to use which most of the time helps in converting inventory to finished goods.
As the sale or purchase of fixed asset is treated separately therefore sometimes accountants use different terms for buying and selling activities of non-current assets. For example term acquisition is used instead of purchase and disposal is used instead of sale. However, context can help us understand what terms imply in a given situation.
On sale (disposal) of fixed asset, before we even think of accounting entries related to disposal activity, we need to take care of three things:
- Cost of the asset that is accounted for in account of asset
- Depreciation of the asset that is accounted for in accumulated depreciation account of relevant class of asset
- Revaluation of asset that is accounted in revaluation account associated to such class of asset
Accounts are maintained in the books of accounts for whole class of asset e.g. building a/c will contain accounting transactions for all the buildings entity controls. But only a particular building if sold then we need to determine the cost of such building or the value associated to such building or if any adjustment is required in its cost then it should be done prior to recording disposal of such asset. The reason is all the transactions related to such asset will be eliminated as this longer entity’s resource so it will be better if all the required cost related adjustments are done. For example recording of capital expenditures made like overhauls or upgradation etc.
Depreciation is another important aspect we cannot ignore. We need to consider entity’s policy regarding depreciation whether it is on daily basis monthly basis or yearly basis etc. Or policy involves more technicalities like full year depreciation in the year of sale or depreciation is charged on the assets held at the year end. In short if there is any depreciation that needs to be recorded before disposal it must be recorded so that expense is charged and appropriately accounted for. This adjustment will be made in accumulated depreciation account which is important for the same reason as with cost that we will be eliminating accumulated depreciation related to asset disposed therefore all relevant adjustments must be made before accounting for sale of asset.
Revaluation if any that has been conducted before disposal and as a result if there is any gain or loss then it must be accounted for. Accounting for revaluation involves much technicalities and demands care on implementing requirements of standards.
After the relevant adjustments are made in relevant accounts a temporary account with the name disposal account will be opened. The cost of the asset disposed will be transferred from asset account to disposal account. The following entry will be made with the cost/value of asset:
Debit: Disposal account
Credit: Asset account
Similarly depreciation of the asset disposed will also be transferred from accumulated depreciation to disposal asset. With these transfers asset is effectively eliminated from the books of accounts. However, accounting for disposal is not yet concluded. The following journal entry will be made with the total accumulated depreciation charged so far:
Debit: Accumulated depreciation account
Credit: Disposal account
After the transfer of cost and accumulated depreciation amounts the consideration received, in cash or in kind, will be recorded in the disposal account. The journal entry to record this is as following:
Debit: Cash a/c (and/or) Asset a/c
Credit: Disposal account
Any balancing figure in the disposal account will indicate gain or loss on disposal and this balance will ultimately be closed in profit and loss account. It can be understood more simply in terms of carrying value. If carrying value of asset is more than consideration received then it is a loss. If carrying amount is less than consideration received than it is a gain on disposal. Closing entry depends on what side the balance is. Under two possible situations entries are as follows:
If balance is on debit side (credit balance):
Debit: Disposal account
Credit: Profit and loss account
If balance is on credit side (debit balance):
Debit: Profit and loss account
Credit: Disposal account
If the asset has any revaluation surplus balance then it can treated in two possible ways:
- transfer revaluation surplus associated to asset to retained earnings
- leave the revaluation surplus as is
In case if entity decides to transfer the revaluation surplus the entry will be:
Debit: Revaluation surplus account
Credit: Retained earnings account
Summary
- Adjust the relevant accounts for any transactions before disposal of assets.
- Transfer cost and accumulated depreciation amounts to disposal account
- Record the consideration received in the disposal account
- Close the account to determine gain or loss on disposal
- Decide about revaluation surplus, if any, as per entity’s policy