How does disposal of an asset through sale, abandonment, or trade-in on another asset affect net income?

Answer 1

DISPOSAL OF ASSETS

Sale of Asset

The firm records the consideration received from the sale (usually cash), eliminates all debits and credits in the accounts related to the asset sold, and recognizes a gain or loss. Because sales of long-lived assets are usually peripheral to a firm's principal business activities, the firm records the gain or loss net instead of gross. That is, the firm does not record the amount received as revenue and the carrying value of the asset sold as an expense. Rather, the firm nets the two amounts and reports only the gain or loss.

Before recording the sale, the firm recognizes depreciation and amortization for the current year up to the date of the sale. When a firm retires an asset from service, it removes the cost of the asset and, in the case of tangible, depreciable assets, the related amount of accumulated depreciation from the books. As part of this entry, the firm records the amount received from the sale, a debit, and the amount of net carrying value removed from the books, a net credit (that is, a credit to the asset account and a smaller debit to the accumulated depreciation account). Typically, the amount of the debit for cash proceeds differs from the net credit to remove the asset from the accounts. The excess of the proceeds received on retirement over the carrying value is a gain (if positive) or a loss (if negative, that is, if net carrying value exceeds proceeds).

Abandonment of Asset

Firms will sometimes abandon assets if there is no market for the asset. Examples include an automobile severely damaged in an accident or a machine requiring an overhaul that is not cost effective. The firm eliminates the carrying value of the asset and recognizes a loss in an amount equal to the carrying value.

Trading in an Asset

A firm may retire an asset from service by trading it in on a new asset. U.S. GAAP and IFRS require that firms record trade-in transactions at fair value, unless they lack commercial substance. An exchange lacks commercial substance if the asset's future cash flows are not expected to change significantly as a result of replacing the old asset with the new one. Firms record trade-ins that lack commercial substance at the carrying value of the exchanged asset.