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Asset Disposal Meaning
Asset disposal is a process that typically involves removing a long-term asset from a business's accounting records by scrapping or selling it. Tracking the disposal is crucial for organizations as the assets represent a substantial capital investment. Moreover, understanding this concept can help companies maintain their accounting records accurately.
Businesses perform this process because of multiple reasons. For example, if the asset's value has fully depreciated or the company does not need the asset even if it is in decent working order. A key benefit of deposing an asset is freeing up cash that the company can use in different business areas.
Table Of Contents
- The asset disposal definition refers to an accounting process organizations use to remove assets, typically long-term ones, from the accounting records by scrapping or selling.
- Performing this process every year allows businesses to ensure their accounting records are clean and updated.
- Businesses may dispose of assets by selling or scrapping them for various reasons. For example, if an asset's maintenance costs exceed its value or an organization replaces an old asset with a new one with the latest technology.
- There are two methods of asset disposal — double declining balance and straight line.
Asset Disposal in Accounting Explained
The asset disposal definition refers to eliminating a company's asset from accounting records, generally by selling or scrapping it. This process enables businesses to keep their accounting records updated and clean. As noted above, companies may dispose of their assets if they have fully appreciated or are no longer useful. That said, there are two more reasons why an organization may remove an asset from its accounting records. Let us look at them.
- Unforeseen Circumstances: Sometimes organizations experience unpredictable circumstances, for example, theft. In such cases, they eliminate the asset from its accounting records.
- Repair Costs Are Higher Than The Asset's Value: The cost of maintaining an asset increases over time. This can cause the expenses to exceed an asset's current value. As a result, organizations may choose to dispose of the asset when the costs exceed its earnings.
Asset disposal in accounting is primarily of two types. They are as follows:
- Normal Disposal: Businesses carry out this process to transfer the asset's ownership to another party, which means an organization gives it away as a gift or sells it. The essential thing, in this case, is the ownership transfer. The new owner may decide to use the asset. Alternatively, they can give to another entity.
- Trading Disposal: Businesses carry out trading disposal when they intend to purchase and utilize an asset as soon as they receive it. This is a kind of normal disposal that involves goods rather than cash. For example, an organization owning a retailer may trade in unnecessary old goods. The business would do this exchange in return for a store credit to purchase new goods for its shelves instead.
That said, one must remember that letting an entity utilize assets without receiving any proper payment is not permitted per accounting standards.
How To Record?
Organizations can follow the steps below to record the disposal of an asset in their accounting records:
#1 - Compute The Depreciation Amount
The first step involves ensuring that the business has the asset's accurate value recorded when disposing of it. Since the value of various long-term assets depreciates with time, companies must factor in the depreciation amount in their records. For this, they must compute the difference between the asset's cost and salvage value and divide the result by the asset's useful life.
#2 - Record The Sale Amount
Businesses must record the loss or gain earned if they sell their asset. That said, they must record it, too, if they donated or threw away the asset. They need to record the cash received and depreciation as asset debit. The asset's original cost and the gains earned from the sale are recorded as asset credit. One must remember that businesses can record the losses as debit. The debit and credit cancel each other if the business follows the step correctly.
#3 - Credit The Asset
A business's main objective of recording full depreciation, losses, or gains is to show the monetary values related to the disposal or sale of its asset. Selling assets for the total depreciated value indicates that the business made no gain or loss upon selling them. Conversely, selling an asset for an amount exceeding the depreciated value means the businesses gained cash from the sale.
On the other hand, selling an asset for an amount below the total depreciated value indicates that the business made a loss on the asset's sale. One must remember that an organization must record gains and losses as credit and debit entries, respectively.
#4 - Eliminate Every Instance Of The Asset From The Other Books
After recording the asset's elimination and the corresponding loss or gain, businesses must remove the asset from other financial records. This will help them avoid accounting errors and confusion.
#5 - Check If The Work Done Is Accurate
Businesses must ensure the figures and math are correct. Additionally, they must check whether they eliminated all records of the assets from their books to finish the process.
Methods
There are two methods of asset disposal. Let us look at them.
#1 - Double Declining Balance
Companies can utilize double declining method to identify how the value of an asset depreciates with time. Computing the disposal value using this technique involves dividing 1 by the useful life of the asset 1 and multiplying the result by 2. This is the depreciation rate.
The formula is as follows:
The Rate of Depreciation = 2 (1 ÷ The Asset’s Useful Life)
Then, businesses must compute the asset's yearly depreciation. For that, they must multiply the asset's value at the start of the financial year or any particular duration by the depreciation rate. The result reflects the depreciation for that specific timeframe.
Next, companies must compute the difference between the asset's initial value and the yearly depreciation to determine the asset's new value.
The formula is as follows:
The Asset's New Value = The Initial Value – Yearly Depreciation
A long-term asset will likely have a new value yearly owing to depreciation. Therefore, businesses must repeat the above steps until their asset is fully depreciated or reaches the salvage value.
#2 - Straight Line
The straight-line method involves using a formula to compute an asset's depreciation. In this case, a business first determines the asset's salvage value and initial cost. The former is the amount an organization expects to get when scrapping or selling an asset. Next, the company computes the difference between the initial cost and the salvage value. Then, it divides the difference by the asset's overall life or total years of usefulness.
The formula is as follows:
Asset Depreciation = (Initial Cost Of The Asset – Salvage Value) ÷ Asset's Life
Businesses can compute the remaining value of assets that have not reached their useful life's end by following these steps:
- Multiply the amount of depreciation by the total years of service offered by the asset to calculate the accumulated depreciation.
- Subtract the accumulated depreciation from the initial cost of the asset.
One must note that the asset's remaining value is the disposal value.
The formula is as follows:
Disposal Value = The Initial Cost of The Asset – (Years of Service x Asset Depreciation)
Journal Entries
Let us look at a few asset disposal journal entries examples to understand the concept better.
Example #1
Suppose Jumbo's Pizza, a pizza restaurant chain, sold a delivery vehicle with an original cost of $20,000 for $10,000 in cash. The accumulated depreciation on that vehicle was $12,000. The company recorded the following entry:
| Debit ($) | Credit ($) | |
|---|---|---|
| Cash | 10,0000 | |
| Accumulated Depreciation | 12,000 | |
| Gain On Disposal | 2,000 | |
| Manufacturing Equipment | 20,000 |
Example #2
Suppose DBS Tires, a Canadian tire manufacturer, sold manufacturing equipment that originally cost $30,000 for $12,000 in cash. The organization compiled an accumulated depreciation of $10,000 on that asset. Let us look at the journal entry passed by the business to dispose of the asset.
| Debit ($) | Credit ($) | |
|---|---|---|
| Cash | 12,000 | |
| Accumulated Depreciation | 10,000 | |
| Loss On Disposal | 8,000 | |
| Manufacturing Equipment | 30,000 |
Advantages
The benefits of asset disposal in accounting are as follows:
- Businesses can dispose of unusable or old assets with new ones to generate more revenue. Moreover, the replacement may add extra value to the business.
- Organizations need not account for the maintenance and repair costs for the asset disposed of.
- As mentioned earlier, Companies can dispose of an unrequired asset by offloading it. This frees up cash and allows them to invest in multiple areas of the business.
Asset Disposal vs Write-Off
Understanding the meaning of asset disposal and write-off can be challenging for individuals new to accounting. That said, knowing the differences between the two concepts can help eliminate any confusion. So, let us look at their distinct features.
| Asset Disposal | Write Off |
|---|---|
| This involves selling an asset in return for sale proceeds. | Writing off an asset implies that a company has no further use for the asset. |
| When businesses dispose of an asset, they debit the sale proceeds and accumulated depreciation accounts and credit the asset's initial cost. Moreover, they record the gain or loss on the disposal by passing a credit or debit entry. | In this case, businesses debit the accumulated depreciation account and credit the asset account. |
Frequently Asked Questions (FAQs)
In the UK, Business Asset Disposal Relief or BADR is a kind of tax relief that reduces the capital gains tax amount due after the disposal of an asset. Previously, this relief was called the ER or Entrepreneur's Relief. However, the Finaneof Act, 2020 updated it.
The loss incurred on a business asset is a non-operating expense.
There is no limit to the number of times entities can claim this relief. That said, one must remember that individuals' claims must not exceed £1 million over their lifetime. Also, one may be able to claim a higher amount if they offloaded their assets before March 11, 2020.
Organizations use this form to document the asset disposal process. For example, state agencies, banks, and other businesses utilize this form to monitor their assets. They also use these forms to record items that they are disposing of.
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