M1L3V1: Disposal of Fixed Assets

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From the course by University of Illinois at Urbana-Champaign

Financial Accounting: Advanced Topics

608 ratings

University of Illinois at Urbana-Champaign

Financial Accounting: Advanced Topics

608 ratings

Course 2 of 7 in the Specialization Financial Management

In this course, you will explore advanced topics in financial accounting. You will start your journey with accounting for assets with more than one-year life. You will learn in detail how firms account for fixed assets. You will then move to financing of assets and discuss accounting for liabilities. The course will continue with an in-depth exploration of shareholders’ equity. Finally, you will critically evaluate preparation, components, and analysis of cash flows statement. Upon successful completion of this course, you will be able to: • Account for fixed assets • Understand accounting for liabilities • Evaluate shareholders’ equity section of a balance sheet • Understand preparation and information provided by cash flows statement This course is part of the iMBA offered by the University of Illinois, a flexible, fully-accredited online MBA at an incredibly competitive price. For more information, please see the Resource page in this course and onlinemba.illinois.edu.

From the lesson

Module 1: Long-Term Assets

Long-term assets, assets that can be converted into cash in a time period of more than one year, constitute a large portion of a balance sheet for a lot of public companies. Understanding accounting for long-term assets will help you uncover how these accounts change over time, their valuation, and their usefulness in managerial decision making.

M1L3V1: Disposal of Fixed Assets3:27

Meet the Instructors

Oktay Urcan
Associate Professor of Accountancy
Department of Accountancy, College of Business

Now we are going to talk about disposal of fixed assets.

When we acquire fixed asset, it doesn't necessarily mean that we use

these assets until the end of their useful life.

There are a lot of cases where fixed assets are sold before their useful life.

And in this scenario, you need to calculate two things for

accounting purposes.

The first one is net book value, NBV.

Net book value is equal to original cost of this fixed asset

minus all accumulated depreciation of this fixed assets.

And the second thing that you need to calculate when you dispose of an asset is

gain or loss coming out of this disposal.

It is calculated as sale price- NBV that you have just calculated.

Let me give you an example.

Again, my classic example Illini Supermarket acquires a truck by paying

$35,000.

It has estimated life of 10 years, salvage value of $2,000.

Well what happens is that after the 5 years of usage,

Illini Supermarket sells this asset for $20,000.

So the question here is, how are we going to do the accounting for this?

But first of all, you need to do accounting for

the 5 years of usage of this fixed asset.

So what's going to happen is that when you acquired this asset

obviously there is a cash decrease of $35,000.

There is a PPE, asset creation of $35,000.

And then you need to record 5 years of usage of this asset

under accumulated depreciation.

As we have calculated in the previous video, annually, the amount of

depreciation is 3,300 times 5 will give you 16,500 under accumulated depreciation.

And note that same number also shows up under retained earnings.

Why?

Normally, accumulated depreciation will show up under income statement, but

we know that the balances at the end of every year

under income statement is transferred to retained earnings.

That's why 16,500 also shows up under retained earnings.

Now, at this point, we are going to sell this asset for $20,000 cash.

Let's sell it.

First of all, there is a cash increase of $20,000.

Second of all, since we sold this asset, you need to close PPE account,

as well as accumulated depreciation associated with this asset.

Therefore notice that PPE account is closed by putting a negative $35,000.

Notice also that accumulated depreciation is also closed by adding a positive

16,500.

So now we are ready.

And we said whenever we dispose of an asset, we need to calculate two things.

The first one was net book value which is equal to original cost of this asset,

in our case it is $35,000,

minus accumulated depreciation of this asset which is 16,500.

If you calculate this, you're going to come up with 18,500,

which is the net book value at the time of sale of this asset.

And the second that you need to calculate when you dispose of an asset was gain or

loss, which is equal to the sale price, in our case it is $20,000,

minus netbook value of this asset which is 18,500.

It's going to give you a gain of 1,500.

And that is going to be recorded under income statements.

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