Lesson Objectives:- Real world example of depreciation and disposal of an asset
- How to calculate depreciation expenses using the straight line method
- Calculating total depreciation and net book value
- Recording gains and disposal
We will start off talking about concept of disposals by looking at a real-world example of a construction truck and how the depreciation is recorded. In this example we will also be looking at how we record the disposal of an asset.
Let's say that Bob's Construction Company purchased a truck for $50,000 on January 1, 2000. The truck has a useful life of 20 years and salvage value for the truck is $0. The company ended up selling the truck for $ 11,500 on June 31, 2015. Another thing to note is that we will be using straight line depreciation to record the depreciation expense.
First, let's determine how much depreciation expense the company has incurred. For the purpose of this example, we will assume that the depreciation expenses have been recorded up until Dec 31, 2014.
In order to find out how much depreciation needs to be recorded using the straight-line method, we will use the formula below. The cost of $50,000 subtracted by the salvage value of $0 then divided by 20 years would give us a depreciation expense of $2,500.
We would next need to calculate how much depreciation expense has been incurred between Dec 31, 2014 and June 31, 2015. The yearly expense amount of $2,500 would simply be multiplied by 6 months out of 12, to come up with the adjusted expense amount of $1,250.
$2,500 x (6/12) = $1,250
To record the journal entry for 2015 prior to the disposal of the asset, the $ 1,250 would debit the depreciation expense and credit the accumulated depreciation account for $1,250.
To find out the total depreciation expense for the time since the asset was purchased, we would take the 15 years that have passed and multiply by the yearly depreciation expense of $2,500. We would then add the $1,250 to account for the 6 months that passed in 2015, which would give us a total of $ 38,750 in accumulated depreciation.
Next, we will need to find the net book value of the truck to record on the balance sheet. The cost of the truck would be recorded for $50,000 less the accumulated depreciation amount of $ 38,750. This would give us a net book value of $ 11,250 which will help us to determine whether the disposal resulted in a gain or loss.
If we compare the net book value of $11,250 to the $11,500 price that the company sold the truck for, we can see that they sold it for more than the net book value. This means that the sale would need to be recorded as a gain of $250.
In order to record the gain, we would first need to debit the cash account as the company is receiving $ 11,500 in cash. The accumulated depreciation account would be debited for $38,750. Since the truck was originally purchased for $50,000, it would be recorded as a credit. The final account to balance out the journal entry would be the gain of $250 as a credit.
This is how the disposal of the asset would be recorded. If the net book value exceeded the sale price, we would have recorded a loss instead. In the case of the construction truck, the company sold it for more than the net book value which resulted in a gain.