Selling a Depreciable Asset

Recording Depreciation to Date of Sale

When a depreciable asset is sold (as opposed to traded-in or exchanged for another asset), a gain or loss on the sale is likely. However, before computing the gain or loss, it is necessary to record the asset’s depreciation right up to the moment of the sale.

To amplify this step, assume that a retailer had recorded depreciation on its fleet of delivery trucks up to December 31. Three weeks later (on January 21), the company sells one of its older delivery trucks. The first step for the retailer is to record the depreciation for the three weeks that the truck was used in January.

Example of a Gain on Sale of an Asset

After an asset’s depreciation is recorded up to the date the asset is sold, the asset’s book value is compared to the amount received. For example, if an old delivery truck is sold and its cost was $80,000 and its accumulated depreciation at the date of the sale is $72,000, the truck’s book value at the date of the sale is $8,000.

If the retailer receives cash of $10,000 for the truck, the retailer will increase its asset cash and will remove from its assets, the truck’s book value of $8,000. Hence, the retailer has a gain of $2,000. This transaction will be recorded as follows:

Example of a Loss on Sale of an Asset

Now let’s assume that the retailer sells the truck for $5,000 (instead of $8,000). The retailer’s cash will increase by $5,000 and its property, plant, and equipment section of the balance sheet will decrease by the book value of $8,000. As a result, the retailer will have a loss of $3,000. This transaction will be recorded as follows:

Other Information Regarding Depreciable Assets

Depreciation of Manufacturing Assets

Assuming a retailer, distributor, or service provider does not manufacture goods, the depreciation associated with its assets will be recorded and reported on its income statement as depreciation expense.

However, if a company’s depreciable assets are used in a manufacturing process, the depreciation of the manufacturing assets will not be reported directly on the income statement as depreciation expense. Instead, this depreciation will be initially recorded as part of manufacturing overhead, which is then allocated (assigned) to the goods that were manufactured.

In other words, the depreciation on the manufacturing facilities and equipment will be attached to the products manufactured. When the goods are in inventory, some of the depreciation is part of the cost of the goods reported as the asset inventory. When the goods are sold, some of the depreciation will move from the asset inventory to the cost of goods sold that is reported on the manufacturer’s income statement.

The depreciation on the non-manufacturing assets (these are assets used in the company’s selling, general and administrative activities) will be reported directly as depreciation expense on the manufacturer’s income statements.

Repairs and Maintenance Vs. Capital Expenditures

After a company’s asset has been put into service, there will likely be some future expenditures associated with the asset. If an expenditure merely maintains the asset (routine and preventative maintenance, tune ups, etc.), the expenditure is immediately reported as an expense such as Repairs and Maintenance Expense. Similarly, if a huge expenditure merely repairs a broken machine, the amount is reported as an expense such as Repairs and Maintenance Expense.

On the other hand, if an expenditure expands or improves an asset’s capabilities, the amount is not reported as an expense. Rather, the cost of the addition or improvement is recorded as an asset and should be depreciated over the remaining useful life of the asset.

The amounts spent to acquire, expand, or improve assets are referred to as capital expenditures. The amount that a company spent on capital expenditures during the accounting period is reported under investing activities on the company’s statement of cash flows.

Depreciation: Allocation Not Valuation

It is important to understand that the main purpose of depreciation is to move the cost of an asset (except the estimated salvage value) from a company’s balance sheet to depreciation expense on its income statements in a systematic manner during the asset’s useful life.

Hence, it is important to understand that depreciation is a process of allocating an asset’s cost to expense over the asset’s useful life. The purpose of depreciation is not to report the asset’s fair market value on the company’s balance sheets.

NOTE:
The purpose of depreciation is to allocate an asset’s cost to expense in a systematic manner.
The purpose of depreciation is not to report an asset’s current value on the company’s balance sheets.

Impairment of Assets Used in a Business

Since depreciation is not intended to report a depreciable asset’s market value, it is possible that the asset’s market value is significantly less than the asset’s book value or carrying amount. The accounting profession has addressed this situation with a mechanism to reduce the asset’s book value and to report the adjustment as an impairment loss.

There are several steps involved in determining whether an impairment loss has occurred and how to measure and report it. You can learn more about impairment losses by reading the appropriate parts of an Intermediate Accounting textbook or visiting the Financial Accounting Standards Board’s website.