Depreciation – Disposal Account

Posted: July 27, 2012 in Accounting Topic

Disposal is generally simple to do, I have not seen students facing much difficulty in a straight forward question. Disposal account is opened upon the sale of an asset, because we have to delete the item from our accounts.

Some important points to take note in this topic:

1) The asset values at its original cost or historical cost.

2) Accumulated depreciation of the asset will have to be disposed of.

3) There is a cash transaction involved for the disposal of the asset (i.e. you sold your asset for cash or trade-in.)

4) There will be a profit or loss arising from such disposal. (No gain no loss could also be possible but rarely occurs.)

5) (*Optional) You will need to charge the profit or loss from disposal to the Profit & Loss Account.

The T-accounts and explanation are shown below:

As an example, if a motor vehicle was purchased at the start of the year at $50,000, and then disposed off at the end of the second year at a disposal value of $35,000. In this case, let’s assume that the depreciation was accumulated to $10,000 (straight line method, $5,000 per year).

Motor Vehicle A/C
1-Jan Cash 50,000 31-Dec Motor Vehicle disposals 50,000
You are disposing of an asset worth
$50,000

Here, students often confused why credit a $ 50,000 motor vehicle account. The reason was obvious, the vehicle that you will throw away is originally worth $50,000. Most students tend to write down the disposal value of $35,000… which is wrong –> Imagine that your motor vehicle was gone and that your motor vehicle account still has a balance carried down of $15,000 ($50,000-$35,000), this is unexplainable (a gone vehicle with a worthiness of $15,000?). Therefore, any assets sold  should be reduced with its original cost.

Provision of Depreciation: Motor Vehicle
31-Dec Motor Vehicle disposals 10,000 31-Dec Balance c/d 10,000

Because we are supposed to close of all accounts related to the motor vehicle that we brought, all relevant accounts should be closed. If you note that the words Motor Vehicle disposals appear in the accounts of Motor Vehicle and Provision for depreciation. This signals another account that will be used to close all relevant accounts. (Take note that the account for provision of depreciation is kinda simplified, it only shows accumulated depreciation for second year.)

Important Information: In this example, the asset was purchased at 1st January and sold at the end of the year of the second year – 31st December, so it has to be fully depreciated for two years. For A Level students, most often, you will need to pay attention to the date and the month of the purchase and accounts for the depreciation accordingly to the months used during the financial year. However, you should also note if there is any additional information given on the company’s depreciation policy. The depreciation policy is to be given highest priority.

Motor Vehicle Disposals A/C
31-Dec Motor Vehicle 50,000 31-Dec Provision for depreciation 10,000
Cash 35,000
Loss on disposal 5,000

Motor Vehicle Disposals account will be the final account. Those that I have embolded means it were transferred from the first two accounts that we closed. The cash will be amount that we received or the amount that the motor vehicle was disposed off. Since every account has to be balanced, there will be shortage of amount in the credit side of the disposal account by $ 5,000. This is a loss on disposal. Can’t picture why? Here, the motor vehicle is worth $50k originally and at the end of the second year, the motor vehicle should worth $40k (after depreciation). And because you sold it for $35k, you are losing the $5,000.

You will also need to note that the reverse of loss on disposal will be on the debit side (profit on disposal).

If the question requires you to open up profit and loss account, then you should! If you are unsure, just note that Loss is an expense, it falls at debit entry in the profit and loss account. Profit is a gain, it falls at credit entry in the profit and loss account. Or you could use double entry rule, the loss on disposal is credit side, so it will falls on the debit side of profit and loss account, and vice versa.

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Comments
  1. Sam Akinwale says:

    Hello, I just want to say a very big thank you to you for this woundaful accounting information. This info has really make my jouning to be a chartered accountat a surccess. Once again, thanks very mush. I will like to receive more updates on accounting from you. Please, I will be expecting it in my e-mail. Am sam from Nigeria.

  2. adebayo toheeb ademola says:

    essential text book

  3. calvo says:

    incredible i must say thank you

  4. Sweva Rodrigo says:

    Wow .. you guys are amazing .. thank you so much ..

  5. shino says:

    hi, I wan to ask this entry is correct? Im not so sure abt the trade in where shld i put. Below is my transaction:-

    MV (new) 28,481
    Accumulated DEpn 25,619
    FV-MV (Old) 25,620
    Trade in amt 2,487
    downpayment (CASh+bank) 5,420
    Loan to bank 20,574

    may I know how to do for this entry.. expecially the Trade in amt,.Hope can receive ur answers ASAP. Thanks

    • rebuters says:

      If you look at it this way, the old vehicle has already been depreciated to NBV of $1 (25,620-25,619). However, you are still able to trade it in at an amount of $2,487. There is a gain of $2,486 (2,487-1).

      The double entry can be simple or complex depending on how you see it.

      Dr Accumulated Depreciation $25,619
      Dr Trade in Amt $ 2,487
      Cr Vehicle $25,620
      Cr Gain in Disposal $ 2,486

  6. shino says:

    ok.. i got it.. anyway, thanks u for ur answers, is useful for me.. thanks 🙂

  7. Jayesh says:

    How can you help me for this question i am unable to find an answer pls.

    Plant and property
    Accumulated depreciation at 1st January 2015 = 210000
    Cost at 1 January 2015 = 258000
    cost at 31 December 2015 = 310000

    Plant and machinery is depreciated at the rate of 10% per annum using the straight-line
    method. A full year’s depreciation is provided in the year of purchase and none in the year of
    disposal. On 1 June 2015 a machine, bought on 10 July 2007, was sold for $17 800. This resulted in a profit on disposal of $13 000.

    Prepare the disposal of machinery account for the year ended 31 December 2015.

  8. rebuters says:

    This is a good example for a very tricky depreciation question. I will try to attempt this through step-by-step so that the readers can benefit from this too.

    1) Disposal Amount = $17.800
    2) Profit on Disposal = $13,000
    3) Ignoring T-account for now, let’s use logic to answer this. Consider this formula: Disposal Value – (Machine Value – Accumulated Depreciation) = Gain/(Loss) on Disposal
    4) The formula for Depreciation = Machine Value/Useful Life but since you are given a % then the Depreciation = 10% x Machine Value
    5) So you can now put equation #4 into equation #3.
    6) You will have Disposal Value – (Machine Value – 10% x Machine Value) = Gain/Loss on Disposal
    7) Calculate the number of years to depreciate the machine. 8 years. Include one year during the year of purchase and do not count the year of disposal.
    8) Compiling everything, you get: 17,800 – (M – (0.10 x 8 x M)) = 13,000
    9) 17,800 – 13,000 = 0.2 M (I hope your algebra is good to understand this!)
    10) M = 24,000 and the D = 0.10 x 8 x M = 19,200
    11) So the double entry will be as follows:
    Machine Value 24,000
    Profit on Disposal 13,000
    Accumulated Depreciation 19,200
    Disposal Amount 17,800

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