Capital assets are those that are expected to generate value for a company over an extended period of time. Common examples of capital assets include manufacturing equipment, computers, and vehicles.
A company might need to eliminate some of its capital assets for a variety of reasons. In many cases, a company will seek to dispose of specific assets like equipment or machinery once the units in question become outdated or become too costly to maintain. Other times, a company might simply run out of space to house its physical assets. When a company disposes of capital assets, it must do so in a manner that adheres to generally accepted accounting principles (GAAP).
Recording the disposal of assets
When a company disposes of a capital asset, that asset must be removed from its balance sheet. This concept is known as derecognition. To dispose of an asset, a company must:
1. Record the asset's depreciation expense up to its sale or disposal date.
2. Remove the asset's cost and accumulated depreciation.
3. Record the amount received for the unwanted asset.
4. Report any difference as either a gain or a loss.
If a company reports a gain on the disposal of capital assets, it is liable to pay taxes on that gain. On the flipside, if a company reports a loss on the disposal of capital assets, it may be allowed to deduct that loss from its income.
Depreciation is a measure of how much of an asset's value has been used up. If a company buys equipment for $100,000 and expects it to have a useful life of 10 years, it can be depreciated for $10,000 a year over the course of 10 years. Depreciation is used to help companies calculate the difference between the cost of a capital asset and its value at the time of its disposal.
If a company purchases equipment with a useful life of 10 years for $100,000, recognizes $10,000 in depreciation per year over a 10-year period, and sells the fully depreciated equipment for $5,000, it must record a $5,000 gain in conjunction with the disposal of the asset.
Depreciation is used to determine an asset's book value, the value at which it is carried on a balance sheet. Book value is calculated by subtracting an asset's accumulated depreciation from its cost. If a company buys equipment for $100,000 and accumulates $70,000 in depreciation, the equipment's book value is $30,000. If the same equipment is sold for $35,000, the company must report a $5,000 gain upon the asset's disposal.
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