When depreciable assets are disposed of at any date other tha’n the end of the year. tin entry should be made to record depreciation for the fraction of the year ending with the date of disposal. If the half-year convention is in use. six months’ depreciation should be recorded on all assets disposed of during the year. In the the disposal of items of plant and equipment, it is assumed that any necessary entries for fractional-period depreciation already have been recorded.
As units of plant arid equipment wear out or become obsolete, they must be scrapped. sold, or traded in on new equipment. Upon the disposal or retirement of a depr«iable asset. the cost of the property is’ removed from the asset account. and the accumulaled depreciation is removed from the related contra-asset account. Assume. for example. &hat office equipment purchased 10 years ago at a cost of $20.000 has been fully depreciated and is no longer useful. The entry to record the scrapping of the worthless equipment is as follows:
Gains and losses on Disposals of Plant and Equipment
Since the residual values and useful lives of plant assets are only estimates, it is not uncommon ‘for plant assets to be sold at prices that differ from their book value at the date of disposal: When plant assets are sold, any gain or loss on the disposal is computed by comparing the book value with the amount received from the sale. A sales price in excess of the book value produces a gain; a sales price below tire book value produces a loss. These gains or losses, if material in amount, should be shown separately in the income statement in computing the income from operations.
Disposal at a Price Above Book Value Assume that a machine that cost $10,000 and currently has a book value of $2,000 is sold for $3,000 cash. The journal entry to record this disposal is as follows:
Disposal at a Price below Book Value Now assume that the same machine is sold for $500. The journal entry in this case would be as follows:
Gains and losses for Income Tax Purposes
As a result of using different depreciation methods, an asset’s basis for tax purposes may differ significantly from its book value in the accounting records. When an asset is retired, any gain or loss is determined by comparing its disposal price with its undepreciated cost. The “undepreciated cost,” however, is book value for purposes of financial reporting and basis for income tax purposes. If the asset’s basis differs from its book value, it follows that the gain or loss computed for income tax purposes will differ from that reported in the company’s financial statements.
To illustrate, let us again refer to. the example of S&G’s delivery truck. Assume that this truck is depreciated by the straight-line method in S&G’s financial statements and is depreciated by MACRS in the company’s income tax returns, In both cases, the coinpany applies the half-year convention. The depreciation to be recognized for both purposes over the life .of the asset is summarized below
The following schedule indicates the book value and the tax basis of this delivery truck at any disposal date in Year 4:
Computing the Gain or Loss The gain or loss to be recognized in the company’s financial statements and income tax returns now may be determined as follows
A Concluding Comment
The accounting rules applicable’ to trade-ins are more complex for the ‘cntity receiving boot than, for the ennty that pays it. Special rules may apply whenever the amount of boot included in a like-kind exchange is unusually small (less than 25(~,of the trunsaction amount). As these special accounting rules do not affect normill trade-ins of used equipment for new; we defer the discussion of such transactions to more advanced accounting courses.
Other Income Tax Reporting Obligations
In the preceding discussions of depreciation for income tax purposes, we have focused primarily on the current MACRS rules. MACRS applies to all assets acquired since December 31. 1986. But assets acquired in earlier years are subject to different tax rules
Large businesses usually have an income tax department within their accounting businesses often delegate most 01″ their tax accounting to a firm of Certified Public Accountants