Reporting the disposal of long-lived assets can be confusing for many accountants.
This article will provide clear guidelines and examples to help you properly account for and disclose long-lived asset disposals under GAAP.
You'll learn key criteria like held for sale classification, impairment testing, derecognition, gain/loss calculations, and more for proper accounting treatment from acquisition to disposal.
Introduction to Long-Lived Asset Disposal
This section provides an overview of long-lived assets, reasons for disposal, and accounting guidelines regarding asset impairment and assets held for sale.
Understanding the Lifecycle of Long-Lived Assets
Long-lived assets like property, plant, and equipment are utilized by businesses over many years. However, changes in business conditions may lead companies to dispose of these assets before the end of their useful lives through sale or abandonment. Some common reasons for asset disposal include:
- Declining demand for the asset's output or services
- Technological obsolescence due to innovations
- Costly maintenance or high operating expenses
- Restructuring or cost reduction initiatives
Deciding when to dispose of a long-lived asset can be a complex process involving strategic considerations around optimization of capital allocation.
Overview of Disposal Methods and Accounting Implications
There are two main methods for disposing of long-lived assets:
- Sale - The asset is sold to another party. The difference between the sale proceeds and the asset's carrying value is recognized as a gain or loss.
- Abandonment - The asset is discarded without receiving compensation. This results in the recognition of a loss equal to the asset's entire carrying value.
In either case, U.S. GAAP requires companies to stop depreciating disposed assets. Special accounting treatment may also be necessary if disposal meets certain impairment or "held for sale" criteria. For example, assets held for sale may need to be presented separately on the balance sheet and recorded at the lower of carrying value or fair value less selling costs.
Properly accounting for long-lived asset disposals can impact financial reporting and require complex judgements around valuation. Companies should have robust policies and procedures around identifying and disposing of assets that no longer contribute meaningful economic benefit.
What is the accounting treatment for asset disposal?
When a company decides to dispose of a long-lived asset that is no longer needed or useful for operations, there are specific accounting guidelines to follow.
The first step is to stop recording depreciation expense on the asset. Next, the asset needs to be removed from the balance sheet by eliminating its cost and related accumulated depreciation.
If the asset is sold, any cash proceeds received should be recognized. The difference between the cash received and net book value of the asset is recorded as a gain or loss on the income statement.
For example, if equipment with an original cost of $100,000 and accumulated depreciation of $70,000 is sold for $20,000, the journal entry would be:
Cash 20,000
Accumulated Depreciation 70,000
Equipment 100,000
Gain on Sale of Equipment 10,000
The $10,000 gain gets reported on the income statement. This reflects the fact that the company received more cash from selling the fully depreciated asset than its net book value.
Properly accounting for long-lived asset disposals removes outdated assets from the books and records any gains or losses upon sale. Following the guidelines ensures the financial statements accurately reflect the transaction.
Why does GAAP require you to depreciate long-lived assets?
Key Takeaways Generally accepted accounting principles (GAAP) state that an expense for a long-lived asset must be recorded in the same accounting period as when the revenue is earned, hence the need for depreciation.
GAAP requires the cost of long-lived assets to be allocated over their estimated useful lives via depreciation for several reasons:
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To match expenses with revenues - Depreciation spreads out the cost of a long-lived asset over its useful life, so that each accounting period records an expense that matches the revenue earned from using that asset. This follows the matching principle.
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To reflect diminishing asset value - Most long-lived assets lose value over time. Depreciation accounts for this diminishing utility and thus provides more accurate financial reporting.
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To provide relevant financial information - Depreciation provides stakeholders with a more transparent view of an organization's capital expenses and asset values over time. This allows for better decision making.
In summary, depreciation of long-lived assets is a key concept under GAAP because it enables businesses to match revenues and expenses properly, reflect asset value changes accurately, and provide relevant financial information to stakeholders. Recording depreciation leads to financial statements that better represent the company's financial position.
What is the statement no 144 accounting for the impairment or disposal of long-lived assets?
This Statement requires that a long-lived asset to be abandoned, exchanged for a similar productive asset, or distributed to owners in a spinoff be considered held and used until it is disposed of.
Specifically, FASB Statement No. 144 provides guidance on accounting for the impairment and disposal of long-lived assets such as:
- Property, plant and equipment
- Intangible assets subject to amortization
Key Points
- Assets to be disposed of should be reported at the lower of carrying amount or fair value less costs to sell, except for assets that are covered by APB Opinion No. 30. Assets covered by APB Opinion No. 30 will continue to be reported at net realizable value.
- Long-lived assets to be held and used should be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.
- Impairment testing involves comparing carrying values to the sum of undiscounted cash flows expected from the use and eventual disposition. An impairment loss should be recognized if the carrying amount is not recoverable and exceeds fair value.
- Gains or losses on disposal of long-lived assets should be recognized when the assets are sold or otherwise disposed of.
In summary, Statement 144 provides a single accounting method for long-lived assets to be disposed of, while also addressing the accounting for impairment of long-lived assets to be held and used. This improves financial reporting by requiring consistent accounting for similar transactions.
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How is the disposal group of a long-lived asset held for sale reported?
The assets and liabilities of the disposal group are separately presented on the face of the balance sheet only in the initial period in which the group is classified as held for sale.
Specifically, when a long-lived asset meets the criteria to be classified as held for sale, it must be:
- Presented separately in the balance sheet
- Not depreciated while classified as held for sale
- Measured at the lower of its carrying amount or fair value less cost to sell
- Presented similar to a current asset, even if it was previously presented as noncurrent
For example, if a company decides in November to sell a piece of machinery, it would reclassify the machinery from property, plant and equipment to assets held for sale in that reporting period. The machinery would be presented separately from other PP&E on the balance sheet for that reporting period.
In the next reporting period (the following year), if the machinery has not yet been sold, it remains classified as held for sale but does not need to be presented separately on the balance sheet. Only in the initial period of classification as held for sale does separate presentation occur.
The key takeaway is that long-lived assets held for sale get special one-time separate presentation treatment on the balance sheet. After that initial period, separate presentation is no longer required even if they remain unsold and held for sale.
Accounting for Impaired Long-Lived Assets
Identifying Signs of Long-Lived Assets Impairment
Long-lived assets like property, plant, and equipment can experience impairment if events or changes in circumstances indicate their carrying value may not be recoverable. Some indicators of potential impairment include:
- A significant decrease in market value of the asset
- Changes in technology, markets, or laws that negatively impact the asset
- A significant adverse change in the extent or manner an asset is used
- Worse-than-expected current period operating cash flows for the asset
- Forecasted undiscounted future cash flows lower than carrying value
If any such events occur, companies should test the asset for impairment.
Long-Lived Assets Impairment Testing Process
To test a long-lived asset for impairment under U.S. GAAP, a company compares the asset's carrying value to the undiscounted future cash flows it expects to generate from use and eventual disposal. The steps are:
- Determine asset's carrying value - This is the asset's cost less accumulated depreciation and amortization.
- Estimate undiscounted future cash flows - Project the total pretax future cash flows expected from the asset's use and disposal.
- Compare carrying value to undiscounted cash flows
- If the undiscounted cash flows exceed the carrying value, no impairment exists.
- If the carrying value exceeds cash flows, record an impairment loss for the difference between the asset's fair value and carrying value.
Impairment of Long-Lived Assets Example
A manufacturing company owns a machine with an original cost of $100,000 and accumulated depreciation of $60,000. Its carrying value is $40,000.
The machine experiences a major breakdown, requiring $20,000 in repairs. This suggests potential impairment. By analyzing expected production volumes, costs, and machine disposal value, the company estimates total undiscounted future cash flows of $30,000.
Since the carrying value of $40,000 exceeds undiscounted cash flows of $30,000, impairment exists. The company determines the machine's fair value is $25,000. So they record a $15,000 impairment loss ($40,000 carrying value - $25,000 fair value).
Recording and Reporting Impairment Losses
Impairment losses are expensed in the income statement, increasing operating expenses and lowering net income for the period. The reduced carrying value due to impairment is accounted for prospectively through depreciation expenses.
Notes to the financial statements should disclose significant impairment losses, including the asset, impairment amount, how fair value was determined, and the reportable segment impacted. SEC registrants have additional disclosure requirements under ASC 360-10.
Classifying and Reporting Assets Held for Sale
This section explains the criteria and accounting treatment for classifying long-lived assets as held for sale.
Held for Sale Criteria U.S. GAAP
According to U.S. GAAP, for an asset to be classified as held for sale, the following criteria must be met:
- Management has approved and committed to a plan to sell the asset
- The asset is available for immediate sale in its present condition
- An active program to locate a buyer has been initiated
- The sale is highly probable within one year
- The asset is being actively marketed at a reasonable price
- Actions to complete the plan indicate it is unlikely that the plan will be withdrawn
If these conditions are met before the end of the reporting period, the asset should be classified as held for sale.
Assets Held for Sale Balance Sheet Presentation Example
When an asset is classified as held for sale, it must be presented separately on the balance sheet. For example:
Balance Sheet (partial)
| Assets | |
|---|---|
| Current assets | $X |
| Long-lived assets held for sale | $Y |
| Other long-lived assets | $Z |
The asset would be presented under long-lived assets held for sale, separately from other current and long-lived assets.
Assets Held for Sale Tax Treatment
Classifying an asset as held for sale may trigger tax implications:
- Assets held for sale are still subject to depreciation until the date of disposal
- The proceeds from the sale may qualify as a capital gain instead of ordinary business income
- There may be tax benefits if the sale results in a loss
Consult a tax professional when assets are reclassified as held for sale.
Assets Held for Sale Example
Company ABC owns a factory that is no longer needed due to changes in operations. On December 1, 20X1, ABC's management decides to sell the factory within the next year. The property meets all held for sale criteria.
ABC would classify the factory as an asset held for sale on the balance sheet as of December 31, 20X1. It would record depreciation expense for the factory up to November 30. Any gain or loss on the sale in 20X2 would impact ABC's capital gains/losses instead of regular business income.
Disposal and Derecognition of Long-Lived Assets
Determining the Gain or Loss on Disposal
When a long-lived asset is disposed of, companies must calculate and record any gain or loss on the transaction. This involves comparing the net proceeds received to the asset's carrying value on the books.
For example, if a piece of equipment with an original cost of $100,000 and accumulated depreciation of $70,000 is sold for $20,000, there would be a $10,000 loss. The net proceeds of $20,000 are less than the net book value of $30,000 (original cost minus accumulated depreciation). This $10,000 loss would be recognized on the income statement in the period of disposal.
Derecognition Criteria and Accounting Entries
According to U.S. GAAP, a long-lived asset can only be removed from the books when it meets certain derecognition criteria. This includes the date when the recipient obtains control and the company has transferred substantially all risks and rewards of ownership.
Once derecognition criteria are met, the asset is removed and any gain or loss is recognized. If disposed of, the equipment account would be credited for the original cost to remove it. A gain or loss account would then be debited or credited, along with a credit to cash for proceeds received.
Considerations for Partial Disposals or Exchanges
If a company only disposes of a portion of a long-lived asset, it must allocate the asset's cost and accumulated depreciation proportionately. Only the disposed portion is removed from the books. Any cash proceeds would be credited along with a gain or loss.
With an exchange of assets, the proceeds would be recorded at the fair value of the new asset received. A gain or loss is still calculated based on the exchanged asset's net book value.
Post-Disposal Responsibilities and Disclosures
After disposal, companies must review remaining useful lives and salvage values of similar assets. Any changes should be accounted for prospectively. Notes to the financial statements should also disclose the disposal details, including the asset, its carrying amount, the amount of gain or loss, and where it is recognized on the income statement.
Key Takeaways and Conclusion
Essential Points on Long-Lived Asset Disposal
When disposing of long-lived assets, there are a few key guidelines to follow:
- Assess the asset for impairment before classifying it as held for sale. If the carrying value exceeds the fair value, recognize an impairment loss.
- Once classified as held for sale, stop depreciating the asset and measure it at the lower of its carrying amount or fair value less costs to sell.
- Present the asset separately on the balance sheet and recognize any subsequent losses as adjustments to its carrying value.
- Disclose details of assets held for sale and any continuing involvement after disposal.
Properly accounting for long-lived asset disposal involves rigorous impairment testing and financial reporting to provide transparency to stakeholders.
Final Thoughts on Asset Disposal and Financial Reporting
Accurately accounting for the disposal of long-lived assets is an important aspect of financial reporting. By following U.S. GAAP guidelines around impairment, measurement, classification, and disclosure, companies can provide investors and stakeholders a transparent view into these transactions.
Rigorous impairment testing procedures also help ensure assets are not overstated on the balance sheet. Ongoing assessments of fair value and subsequent losses prevent carrying amounts from exceeding realizable values.
Overall, compliance with disposal and impairment standards leads to financial statements that more accurately reflect a company's financial health and performance. This enables stakeholders to make better informed decisions based on a true representation of long-lived asset values.
