Adjustments and the Worksheet Chapter 18 Adjustments and the Worksheet Section 2: Disposition of Assets Section Objectives Section 2 of the chapter explains how to dispose of long term assets. Record sales of plant and equipment. 5. Record asset trade-ins using financial accounting rules and income tax requirements.

Proceeds – Book Value = Gain or loss Businesses routinely sell or dispose of plant assets that are no longer useful to the business. When assets are disposed of, the business often incurs a gain or loss. Assets may be disposed of in several ways by a business including being thrown away, sold outright, or traded for another item. When an asset is disposed of, the transaction may result in a gain or loss. Proceeds – Book Value = Gain or loss

A gain is the disposition of an asset for more than its book value. QUESTION: What is a gain? A gain is the disposition of an asset for more than its book value. ANSWER: A gain is the disposition of an asset for more than its book value.

A loss is a disposition of an asset for less than its book value. QUESTION: What is a loss? A loss is a disposition of an asset for less than its book value. ANSWER: A loss is a disposition of an asset for less than its book value.

Methods of Disposition Scrapping or discarding Sale Trade-in for a similar asset When we dispose of an asset, all of its related accounts must be removed from the books (the asset account itself and any accumulated depreciation associated with it.) A business can dispose of an asset in several ways. . . Scrapping or discarding Sale Trade-in for a similar asset

Disposal by Scrapping or Discarding When an asset is worn out, often it is simply discarded. If the discarded asset is not fully depreciated, depreciation is recorded up to the date of disposal. Prior to removing a capital asset from your books, all depreciation expense needs to be recorded up to the date of the disposal. A loss may be incurred upon disposal if the book value of the asset is less than the proceeds.

Objective 4. Record Sales Of Plant And Equipment. A business may dispose of an asset by selling it.

Disposal by Sale Step 1. Record depreciation to the date of disposition. Step 2. Remove the cost of the asset. Step 3. Remove the accumulated depreciation. Step 4. Record the proceeds. Step 5. Determine and record the gain or loss, if any. Before taking an asset off of the business’s books because it was sold, we need to update depreciation expense up to the date of the sale. A loss or a gain may result on the sale if the proceeds received are less than (loss), or greater than (gain) the book value of the asset. When recording the sale, the asset account should be removed from the books as well as its associated accumulated depreciation.

Sale at Book Value Income Statement If the asset is sold for the same amount as the book value, there is no gain or loss. Sale at Book Value Income Statement Balance Sheet No change in net income If the asset is sold for same amount as the book value, there is no gain or loss. There would be no change in net income for the period and total assets would stay the same. No change in equity

Gain on Sale Net Income Assets Equity Sale Above Book Value If the asset is sold for more than book value, there is a gain. Sale Above Book Value Income Statement Balance Sheet Gain on Sale Net Income If the asset is sold for more than book value, there is a gain. The gain would be reported on the income statement and total assets and equity would go up on the balance sheet. Assets Equity

Loss on Sale Net Income Assets Equity Sale Below Book Value If the asset is sold for less than book value, there is a loss. Sale Below Book Value Income Statement Balance Sheet Loss on Sale Net Income If the asset is sold for less than book value, there is a loss. The loss would be reported on the income statement and total assets and total equity would go down on the balance sheet. Assets Equity

Objective 5. Record asset trade-ins using the income tax method and the fair market value method. Businesses often trade in old equipment when they purchase new equipment.

Disposal by Trade-in Step 1 Record the depreciation up to the date of trade-in. Step 2 Record the trade-in of the old asset and the purchase of the new asset. Use either: the financial accounting rules, or the income tax rules. When recording a trade-in it is very similar to a sale except we have to add a new asset as well as remove an old one. Always remember to update the depreciation account up to the date of the sale then record the trade-in of the old asset and the purchased of the new asset. If a gain or loss occurs involving the trade-in of another asset we have to determine if the trade was for a similar asset or a non-similar asset. To record the transaction we use either: the financial accounting rules, or the income tax rules

What are the financial accounting QUESTION: What are the financial accounting rules for trade-ins of similar assets? The financial accounting rules allow a loss to be recognized on the trade-in of a similar asset. ANSWER: The Financial Accounting Rules for Trade-Ins are: All losses are recorded. Only gains on non-similar asset trades are recorded. Gains on similar asset trades reduce the recorded cost of the new asset. A gain is not recognized!!

Applying the Financial Accounting Rules if there is a loss on the trade-in: Step 1. Remove the cost of the old asset. Step 2. Remove the accumulated depreciation for the old asset. Step 3. Record the payment. Step 4. Record the new asset at its fair market value. Step 5. Determine and record the loss. If there is a loss on the trade-in, we would follow these steps:

Financial Accounting Rules Formula for determining loss or gain: Trade-in allowance – (Book value) = (Loss) or gain If the trade in allowance is greater than the book value of the asset, then their exists a gain. If however, the trade-in allowance is less than the book value of the asset, then there is a loss on the exchange.

Financial Accounting Rules Gain: (Trade in > Book Value of old.) Gain not recognized!! New asset’s recorded cost: Book value of old asset + Cash Payment = Recorded cost of new asset If there is a gain on the trade in then no gain is recognized. Instead, the recorded cost of the new asset is the book value of the old asset + any cash payment made upon the exchange. If a loss occurs on the trade in, then recognize and record the loss in the books in the new account called “Loss on Trade-in of Plant Asset”. Loss: (Trade in < Book Value of old) Recognize loss in Loss on Trade-in of Plant Asset.

What is the income tax method? QUESTION: What is the income tax method? The income tax method records the trade-in of an asset according to income tax rules. ANSWER: For income tax purposes, the exchange of similar assets (e.g., a car for a car) results in no recognition of a gain or loss on the books. Income tax rules do not recognize gain or loss on a trade-in.

Income Tax Method Step 1. Remove the cost of the old asset. Step 2. Remove the accumulated depreciation for the old asset. Step 3. Record the payment. Step 4. Determine and record the cost of the new asset. These are the steps used to record the exchange using the income tax method.

Income Tax Method Formula for the new asset: Book Value of the old asset + Payment for the new asset = Cost of the new asset The cost or tax basis of the new asset is: the book value of the old asset + the amount paid for the new asset.

Income Tax Method Gain: Not recognized. A gain simply reduces the new asset’s cost. Loss: Not recognized. A loss simply increases the tax basis (historical cost for tax purposes). Using the rules for Income tax purposes of a Trade-In if Gain is Realized on the transaction there is no gain recorded. Using the rules for Income tax purposes of a Trade-In if Loss is Realized on the transaction there is no loss recorded.

Income Tax Method Recall that conservatism requires that the method that is least likely to overstate income should be used. Therefore, under GAAP, a loss must be recorded. However, some argue that the income tax method is acceptable (no loss recorded) if the loss is not material. Recall that conservatism requires that the method that is least likely to overstate income should be used. Therefore, under GAAP, a loss must be recorded.

Complete the following sentences: SECTION R E V I W Complete the following sentences: gain A ____ is the disposal of an asset for more than its book value. A ____ is the disposal of an asset for less than its book value. loss How many of these review questions can you get right? Assets may be disposed of by __________, ____, or _______. discarding sale trade-in

Complete the following sentences: R E V I W SECTION Complete the following sentences: Sale at book value does not change the __________ on the income statement. net income Under the _________________, when a business asset is traded in, no gain or loss is recorded. income tax method Under the fair market value method, when a business asset is traded in, ______ are recognized but _____ are not recognized. losses gains

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