Principles of Financial Accounting: Plant Assets and Intangibles - Disposal of Plant, Assets Retirement Sale Exchange

What It Is

Disposal of plant assets, also known as retirement, sale, or exchange, occurs when a company gets rid of a long-term asset, such as property, plant, or equipment (PP&E). This can happen through retirement (scrapping or disposing of the asset), sale, or exchange (trading one asset for another). Accurately accounting for the disposal of plant assets is crucial for financial reporting, as it affects a company's financial statements, including the balance sheet and income statement.

Key Concepts & Formulas

• Cost of disposal: The cost associated with disposing of a plant asset, such as removal costs or disposal fees. Example: A company spends $1,000 to remove and dispose of a piece of equipment. The cost of disposal is $1,000.
• Gain or loss on disposal: The difference between the sale price or exchange value and the asset's carrying value (net book value). Example: A company sells a piece of equipment for $10,000, but its carrying value is $8,000. The gain on disposal is $2,000.
• Accumulated depreciation: The total depreciation expense recorded for a plant asset over its useful life. Example: A company has accumulated $5,000 in depreciation for a piece of equipment with a carrying value of $8,000.
• Carrying value: The asset's net book value, which is the cost minus accumulated depreciation. Example: A company purchases a piece of equipment for $10,000 and has accumulated $5,000 in depreciation. The carrying value is $5,000.
• Depreciation method: The method used to calculate depreciation, such as straight-line or units-of-production. Example: A company uses the straight-line method to depreciate a piece of equipment over 5 years.
• Useful life: The estimated number of years a plant asset will be used. Example: A company estimates that a piece of equipment will have a useful life of 5 years.
• Salvage value: The estimated value of a plant asset at the end of its useful life. Example: A company estimates that a piece of equipment will have a salvage value of $1,000 at the end of its useful life.
• Retirement method: The method used to record the disposal of a plant asset, such as the straight-line method or the units-of-production method. Example: A company uses the straight-line method to record the retirement of a piece of equipment.
• Exchange value: The value of the asset received in an exchange. Example: A company exchanges a piece of equipment for a new machine worth $10,000.

Journal Entry Examples

Example 1: Retirement of a Plant Asset

Dr. Accumulated Depreciation - Equipment $5,000 Cr. Equipment $5,000 Cr. Loss on Disposal of Equipment $2,000

Explanation: The company retires a piece of equipment with a carrying value of $5,000 and a salvage value of $3,000. The loss on disposal is $2,000.

Example 2: Sale of a Plant Asset

Dr. Cash $10,000 Cr. Equipment $8,000 Cr. Gain on Sale of Equipment $2,000

Explanation: The company sells a piece of equipment for $10,000, but its carrying value is $8,000. The gain on sale is $2,000.

Example 3: Exchange of a Plant Asset

Dr. Equipment $10,000 Cr. Accumulated Depreciation - Equipment $5,000 Cr. Loss on Disposal of Equipment $2,000 Cr. Equipment $10,000

Explanation: The company exchanges a piece of equipment for a new machine worth $10,000. The loss on disposal is $2,000.

Common Mistakes

Mistake 1: Confusing Debits and Credits for Expense Accounts

• Correction: Expense accounts are debited, not credited. Remember the rule: "Expenses are debited, revenues are credited."
• Mnemonic: "E-D-R-C" (Expenses Debit, Revenues Credit)

Mistake 2: Failing to Record Accumulated Depreciation

• Correction: Accumulated depreciation is recorded as a contra-asset account, which means it is debited when depreciation is recorded and credited when the asset is disposed of.
• Mnemonic: "A-D-C" (Accumulated Depreciation Credit, Depreciation Debit)

Mistake 3: Ignoring Salvage Value

• Correction: Salvage value is the estimated value of a plant asset at the end of its useful life. It should be recorded as a credit when the asset is disposed of.
• Mnemonic: "S-V" (Salvage Value)

Exam Tips

Tip 1: Remember the Rule for Debits and Credits

• Tip: "Expenses are debited, revenues are credited." This rule applies to all expense accounts, including depreciation.

Tip 2: Watch Out for Reversing Normal Balances

• Tip: When recording the disposal of a plant asset, be careful not to reverse the normal balance of the asset account. Instead, debit the asset account and credit the accumulated depreciation account.

Tip 3: Use the Straight-Line Method for Depreciation

• Tip: The straight-line method is the most common method used to calculate depreciation. It assumes that the asset will be used evenly over its useful life.

Quick Practice

Problem 1: Retirement of a Plant Asset

A company retires a piece of equipment with a carrying value of $5,000 and a salvage value of $3,000. What is the adjusting entry for the loss on disposal?

Answer: Dr. Accumulated Depreciation - Equipment $2,000, Cr. Equipment $2,000

Explanation: The loss on disposal is the difference between the carrying value and the salvage value.

Problem 2: Sale of a Plant Asset

A company sells a piece of equipment for $10,000, but its carrying value is $8,000. What is the adjusting entry for the gain on sale?

Answer: Dr. Cash $10,000, Cr. Equipment $8,000, Cr. Gain on Sale of Equipment $2,000

Explanation: The gain on sale is the difference between the sale price and the carrying value.

Problem 3: Exchange of a Plant Asset

A company exchanges a piece of equipment for a new machine worth $10,000. What is the adjusting entry for the loss on disposal?

Answer: Dr. Equipment $10,000, Cr. Accumulated Depreciation - Equipment $5,000, Cr. Loss on Disposal of Equipment $2,000

Explanation: The loss on disposal is the difference between the carrying value and the exchange value.

Last-Minute Cram Sheet

1. Dividends are NOT an expense – they go directly to retained earnings.
2. Accumulated depreciation is a contra-asset account.
3. Salvage value is the estimated value of a plant asset at the end of its useful life.
4. The straight-line method is the most common method used to calculate depreciation.
5. Expenses are debited, revenues are credited.
6. Depreciation is recorded as a debit, not a credit.
7. The carrying value of a plant asset is the cost minus accumulated depreciation.
8. The exchange value of a plant asset is the value received in an exchange.
9. The gain or loss on disposal is the difference between the sale price or exchange value and the carrying value.
10. The retirement method is the method used to record the disposal of a plant asset.