A brief description of how to figure the gain or loss on the sale or discard of a fixed asset.
The definition of Gain and Loss is as follows:
Gain: When the sales price of a fixed asset exceeds the fixed asset's book value.
Loss: When the sales price of a fixed asset is lower than the fixed asset's book value.
How would you feel if you sold one of your fixed assets in your business for $2500, deposited that amount in your bank account, recorded it as revenue, paid taxes on the profit, and then, found out you only needed to report $500 not $2500? Kind of foolish maybe? It happens all the time, because people don't know how to figure the gain or loss from the disposition of their assets.
Knowing how to write the proper adjusting journal entries that will record all the parts of a sale or trade of your fixed assets is a little complicated, especially when it comes to trades, and not possible to explain entirely in this article. The subject matter is thoroughly discussed my Real Life Accounting for Non-Accountants course. However, I can demonstrate some of the mechanics involved so that you will be aware that, when you sell or discard an asset, there is more to consider than meets the eye.
For example, let's assume that you bought an office desk for $2500 and depreciated it using the Double-Declining method with a one-half year convention. In the U.S. this is called MACRS (pronounced “makers”) or Modified Asset Cost Recovery System. The MACRS system requires a desk to be depreciated over seven years. Three years later, you decide the desk size is too small, so you sell it for $1800. The first step in determining the gain or loss on the sale is to figure out what the book value of the desk is. This is fairly easy to do if you have maintained a depreciation schedule for the desk. Set up a format such as this:
Original Cost Desk: $2,500.00
Depreciation:
Year 1) $357.25
Year 2) $612.25
Year 3) $218.63
Total Depreciation:
Book Value of Desk: $1,316.87
Desk Sales Price:_
Gain on the Desk Sale:$483.13
Why is it a gain? Review the above definition. The sale price exceeds the book value. All this may seem like 2+2=4 to the experienced person, but for newbies it may be helpful to review the underlying concepts. In my course, I like to encourage students to think of these accounting events in terms of what actually took place physically. For instance, you bought a desk and used it for three years. You did not deduct the entire desk the first year you bought it. As a matter of fact, you only deducted an expense of $357.25. During the next two years you only deducted $830.88. Therefore, your fixed asset, called a desk, has a remaining cost basis of $1,316.87. Since you sold that asset for more than your cost basis, you incurred a gain. The Internal Revenue Service requires that that gain be reported as income and taxed accordingly.
On the other hand, had the sales price been only $800, then you would have incurred a loss of $516.87. This makes sense, because your cost basis was $1,316.87 and you only received $800.00 when you sold it. Therefore, the money you lost on the sale is a cost of doing business, and according to U.S. tax law, a deductible item.
So be careful when selling an asset. You don't want to report more income than is necessary, nor do you want to lose the benefit of a deduction. That is, unless you don't mind paying extra taxes to the government.
About the Author
John W. Day, MBA is the author of Real Life Accounting for Non-Accountants, an online course in accounting basics. He has written 3 e-Books pertaining to small business accounting and writes a monthly newsletter on accounting issues.