University:
California State University, Northridge
Course:
FIN 303 | Financial Management
Academic year:

2024
Views:

235

Pages:

2
Author:

Hugh Kaufman

Example of Gain or Loss on the Sale of Fixed Assets and the Cash Flow Statement When fixed assets are sold, by definition, money is, or will be received. The result is entries to Cash or Accounts Receivable. You must also make entries to remove the Asset from the books and to remove any Accumulated Depreciation on the books for that Asset. The result is that the sum of the debits will not equal the credits in this transaction. The account that will be used to balance the debits and credits is called Gain on Disposition of Fixed Assets. The following example will help explain these entries. Consider a machine is originally purchased for $10,000 and is depreciated for 5 years using the straight-line method with $0 salvage value. After 2 years the entries in the Ledger would look like this: Equipment – Machine A $10,000 Accumulated Depreciation $2,000 (yr 1) $2,000 (yr 2) Now you decide to sell the machine for $8,000. You will make entries that zero-out the Equipment and Accumulated Depreciation accounts (since they will no longer exist) and you must also account for the Cash or Accounts Receivable you now have due to the sale. These Journal entries will look like this: Dr. Cash Dr. Accumulated Depreciation Cr. Equipment – Machine A $8,000 4,000 $12,000 $10,000 $10,000 But you will notice that the Debits and Credits do not match. This is corrected by using an account called Gain (Loss) on the Disposition of Assets or similar. A Debit entry is a Loss (like an Expense) and a Credit entry is a Gain (like a Revenue). In this case there will be a $2,000 Credit entry as shown below: Dr. Cash Dr. Accumulated Depreciation Cr. Equipment – Machine A Cr. Gain (Loss) on Disposition $8,000 4,000 $12,000 $10,000 $2,000 $12,000 Now debits and credits balance! How does this transaction affect the Cash Flow Statement. You will notice that the total value of Fixed Assets will be reduced on the Balance Sheet (a Source of Cash) and you have increased the Cash account. These account for the cash flows from the transaction. One other effect is the Gain (Loss) on Disposition is also a NON-CASH transaction that appears on the Income Statement and increases or decreases taxable income. Similar to Depreciation Expense, it is a non-cash transaction which over-states or under-states Net Income Before Taxes (NBIT). The Income Statement may look like this: Revenues less Expenses Operating Profit Other Income/Expenses Gain (Loss) on Disposition Net Income Before Taxes Taxes Net Income $100,000 $20,000 $80,000 $2,000 $82,000 $5,000 $77,000 In this example Net Income was over-stated by $2,000 by this non-cash transaction (Depreciation Expense under-states Net Income as a non-cash expense). Therefore, you must subtract this non-cash transaction on the Cash Flow Statement to compensate for the over-statement of Net Income. This is under Cash Flows from Operating Activities as with Depreciation Expense.