Disposal Account

A disposal account refers to a nominal account that records the gain or loss on the sale or liquidation of a company's fixed asset. It is the difference between the net carrying value and the proceeds on sale of the disposed asset, and it appears on the firm's income statement.

It is an account prepared to document the non-operating income or loss that arises when a business entity eliminates a fixed asset. This could be due to reasons such as being old, redundant, depreciated, donated, or lost due to theft or fire. As this income recognition doesn't arise from regular business operations, it is recorded separately. 

The disposal account is an income statement account that documents the gain or loss on the sale, donation, or loss of a fixed asset. A fixed asset's book value is often recorded after charging the accumulated depreciation over its lifetime of usage in the company. The firm sometimes uses an asset to the fullest until it becomes obsolete or, due to a change in technology or structure, doesn't need that particular item anymore. Also, at times, the asset gets stolen or donated by the organization. In all these instances, it needs to be removed from the company's financial records through the creation of an asset disposal account. 

The recording of asset disposals involves the reversal of both accounted fixed asset costs and corresponding accumulated depreciation. It involves the following steps: 

1. Subtract the asset's carrying value from its net disposal proceeds.
2. Ensure the firm's balance sheet reflects the fixed assets and the overall depreciation of these assets.
3. For the assets with no book value or total depreciation, all accumulated depreciation is debited, and the relevant fixed asset is credited.
4. If the asset disposal incurs a loss, the cash received on sale, loss on such disposal, and all accumulated depreciation are debited while the relevant fixed asset is credited.
5. If the company makes a gain on asset disposal, then the cash received on such sale and overall accumulated depreciation are debited, while the fixed asset's carrying cost as per books and the gain on the fixed asset's sale is credited. 

The disposal account format involves debiting the relevant asset disposal account against the asset's realized value and the gain recorded in Profit & Loss A/c. Conversely, in the case of loss, the relevant asset disposal account is credited, while the asset and Profit & Loss A/c are debited. 

Let us understand how a disposal account helps the business streamline its financial records by eliminating the fixed assets that are no longer available for use. Given below are some instances:

Example #1

Suppose ABC Ltd. had purchased a commercial vehicle in January 2016 for $12,000 with an estimated life of 10 years. The vehicle depreciates @10% p.a. by the straight-line method and would have fully depreciated by 2025. However, in January 2024, the company sold the vehicle for $4,000. The relevant disposal account journal entries are as follows:

Solution:

Given:

• Cost Price = $12,000
• Depreciation = 10% p.a.
• Proceed on Sale of Vehicle = $4000 
• Residual Value = 0
• Accumulated Depreciation = (10% of $12,000) * 8 = 9,600
• Carrying Vehicle Value = $12,000 - $9,600 = $2,400
• Asset Disposal Gain/Loss = $4,000 - $2,400 = $1,600 

In this example, the company made a gain from the sale of the motor vehicle. 

Example #2

Let us consider another example: XYZ Pharmaceuticals Ltd., heavily invested in medical research, plans to replace its old gene examination machinery with a new one with the latest technology. After considering the accumulated depreciation, the machinery's carrying cost appears to be $15,000 in the company's books. However, the company was unable to sell it as a whole. Therefore, it scrapped the machinery and realized $6,000. Hence, the company incurred a loss of $9,000 ($15,000 - $6,000) on discarding this item from their financial records. This was recorded as a loss in the machinery disposal account under the income statement.

A company typically prepares the disposal account in three prominent situations: 

1. Fully Depreciated Asset: The company records a fixed asset in a disposal account when its entire value is charged for depreciation. In such a case, the accumulated depreciation is considered for crediting the value of the fixed asset. The calculation involves dividing the asset's cost (minus salvage value) over its useful life. This process continues until the asset's value reaches 0 or it is disposed of through sale or gift.
2. Sale, Donation, or Scrapping of Asset: Companies use this account to eliminate assets that are sold off, donated, or become obsolete from their accounting books. When the business disposes of an asset, it encounters either no proceeds or gains/losses based on the difference between accumulated depreciation and sale proceeds. This account documents the net disposal proceeds by subtracting the asset's current value from gains or losses. 
3. Asset Loss in Unforeseen Events: Sometimes, the company faces a loss of fixed assets in theft or fire, which necessitates deducting the value of such an asset from the total equity. In the event of theft, the company creates a theft expense account. The difference between the value of the accumulated depreciation and the recorded stolen capital amount is considered a theft expense.