In the normal course of doing business, a company rids itself of unneeded fixed assets. Different ways they may do this include selling the asset, trading it in on a new fixed asset, junking it, or doing involuntary conversion. Junking an asset means it’s totally worn out and thrown away. Involuntary conversion can occur when the asset is destroyed in a fire or stolen.
Whatever the circumstance, you need to make sure the company has completely removed the cost of the asset and its accumulated depreciation from the balance sheet. Additionally, if the company made or lost any money with the transaction, that amount has to be recorded on the income statement.
How to record sales
To calculate gain or loss on the sale of a fixed asset, book value of the asset is figured up to the date of sale. So if the sale took place on October 1, the company must calculate depreciation from January 1 through September 30.
The asset has to be completely removed from the balance sheet so that the cost of the asset is reduced to zero and so is the accumulated depreciation.
For example, say that a business sells equipment with a net book value of $5,000 (cost is $20,000 and accumulated depreciation is $15,000) for $8,000 on December 31. Gain on sale is $3,000 ($8,000 sales price minus $5,000 book).
This amount is recorded on the books by debiting cash for $8,000, debiting accumulated depreciation for $15,000, crediting the income statement account gain on disposal of asset for $3,000, and crediting the asset account for $20,000.
The same general routine applies for junking assets, although the effect to the income statement is called loss on abandonment.
How to deal with involuntary conversions
If an involuntary conversion takes place, the company has to record the difference between insurance proceeds and the asset’s net book value as gain or loss on disposal of the asset. Suppose that, instead of selling the equipment, a thief breaks into the business during the night and steals it.
The company reports the thief to its insurance provider, which, after subtracting the deductible, cuts the company a check for $4,000. The following figure shows the journal entry to record this transaction.
