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Disposals of Property, plant, and equipment (PPE) in Financial Accounting

Firms frequently sell fixed assets when needs change or when assets age or become obsolete due to technological advances. To illustrate the accounting for a disposal, assume that the machine described in the previous section was depreciated for two years, using the straight-line method. At that point, the machine’s book value is $3,100 ($4,900 $1,800). Also assume that the asset was sold at the beginning of year 3 for $2,500. Because an asset with a book value of $3,100 was sold for $2,500, the firm incurred a $600 loss. The analysis increases cash by $2,500, reduces the asset machine by $4,900, eliminates accumulated depreciation of $1,800, and decreases shareholders’ equity via a $600 loss.

Gains and losses on sales of property, plant, and equipment are included in the income statement. If material, they are separately disclosed; otherwise, they are combined with other items. These gains and losses must be interpreted carefully. First, note that the loss just illustrated is associated with a cash inflow.Therefore, the firm’s overall cash position has improved, even though a loss is reported on the income statement.

Second, gains and losses on fixed asset disposals do not necessarily reflect good or poor managerial performance in the year of the disposal. They may be more a function of poorly estimated depreciation charges. Finally, managers have considerable discretion over the timing of these transactions. Therefore, whenever gains or losses appear on the income statement, the reader must always assess the possible reasons behind such gains or losses.

Property, Plant, and Equipment (PPE) Topics

Related Noncurrent Assets Topics