Fixed Assets (Grade 11 NSC Matric Accounting): Revision Notes

Disposal of a Fixed Asset

Understanding asset disposal

When a business owns a fixed asset (such as equipment, vehicles, or furniture), it uses that asset to help generate income. However, over time, assets may become old, inefficient, or no longer useful to the business. When an asset stops providing economic benefits, it is better to dispose of it rather than continue incurring costs to maintain it.

Disposal means removing an asset from the business records. There are several ways a business can dispose of a fixed asset:

• Sold for cash: The asset is sold and payment is received immediately
• Sold on credit: The asset is sold but payment will be received later (creating a debtor)
• Traded in: The asset is exchanged as part payment for a new asset
• Withdrawn by owner: The owner takes the asset for personal use
• Donated: The asset is given away to charity or another organisation

Understanding how to account for asset disposal is important because it affects the business's financial statements and helps management make informed decisions about when to replace assets.

Information needed for disposal

Before you can account for the disposal of a fixed asset, you need to gather four key pieces of information from the business records:

Cost price

This is the original purchase price of the asset. You can find this information in the asset account or asset register. The cost price never changes, even as the asset ages.

Accumulated depreciation

This represents the total amount of depreciation that has been charged on the asset from the date of purchase up to the date of disposal. Accumulated depreciation shows how much of the asset's value has been "used up" over time. You must ensure this amount is up to date by calculating any depreciation for the current year up to the disposal date.

Amount received for disposal

You need to record the amount for which the asset was sold, traded in, or withdrawn. Keep careful records of this transaction. If the asset is donated, this amount will be zero.

Profit or loss on disposal

Once you have the carrying value and the disposal amount, you can calculate whether the business made a profit or a loss on the disposal. This calculation shows whether the asset was sold for more or less than its book value.

Calculating disposal values

Carrying value

The carrying value (also called book value) represents the current value of the asset in the business's records. It shows what the asset is worth on paper after accounting for depreciation.

The formula for carrying value is:

$\text{Carrying value} = \text{Cost price} - \text{Accumulated depreciation}$

For example, if a computer cost R8 000 and has accumulated depreciation of R3 000, the carrying value is:

$\text{Carrying value} = \text{R}8\,000 - \text{R}3\,000 = \text{R}5\,000$

Pro rata depreciation

When an asset is disposed of during the financial year (not on the last day), you must calculate pro rata depreciation. This means calculating depreciation for only the portion of the year that the business owned and used the asset.

To calculate pro rata depreciation:

$\text{Pro rata depreciation} = \text{Annual depreciation} \times \left(\frac{\text{Number of months owned}}{12}\right)$

For instance, if annual depreciation is R2 000 and the asset was owned for 6 months of the year:

$\text{Pro rata depreciation} = \text{R}2\,000 \times \left(\frac{6}{12}\right) = \text{R}1\,000$

Remember to always calculate depreciation up to the date of disposal to ensure your accumulated depreciation is accurate.

Profit or loss on disposal

After determining the carrying value, you can calculate the profit or loss:

$\text{Profit/Loss on disposal} = \text{Amount received} - \text{Carrying value}$

• If the amount received is more than the carrying value, the business makes a profit
• If the amount received is less than the carrying value, the business makes a loss

For example:

• If you sell an asset with a carrying value of R5 000 for R7 000, you make a profit of R2 000
• If you sell an asset with a carrying value of R5 000 for R4 000, you make a loss of R1 000

Accounting entries for disposal

When disposing of a fixed asset, you need to make several accounting entries to properly remove the asset from your books and record the outcome of the transaction.

Journal entries required

The disposal process involves the following entries in the General Journal:

1. Transfer the cost price: Debit Asset disposal account and Credit the original asset account (e.g., Equipment) with the cost price

2. Transfer accumulated depreciation: First, you may need to write off pro rata depreciation for the current year. Then, debit the Accumulated depreciation account and Credit Asset disposal account with the total accumulated depreciation

3. Record the proceeds:

   • For a cash sale: Debit Bank and Credit Asset disposal
   • For a credit sale: Debit Debtors control and Credit Asset disposal
   • For a trade-in: Debit Creditors control and Credit Asset disposal
   • For a withdrawal: Debit Drawings and Credit Asset disposal
   • For a donation: Debit Donations and Credit Asset disposal

4. Record the profit or loss:

   • For a profit: Debit Asset disposal and Credit Profit on sale of asset
   • For a loss: Debit Loss on sale of asset and Credit Asset disposal

Effect on the accounting equation

Different disposal methods affect the accounting equation (Assets = Owner's Equity + Liabilities) in different ways:

Sold for cash:

• Assets: +Cash, -Asset (net effect depends on profit/loss)
• Owner's Equity: +Profit on disposal

Sold on credit:

• Assets: +Debtor, -Asset (net effect depends on profit/loss)
• Owner's Equity: +Profit on disposal

Traded in:

• Assets: -Old asset, +New asset (combined transaction)
• Owner's Equity: +Profit on disposal
• Liabilities: +Amount still owed (if purchased on credit)

Withdrawn by owner:

• Assets: -Asset
• Owner's Equity: +Profit on disposal, -Drawings

Donated by business:

• Assets: -Asset
• Owner's Equity: +Profit on disposal, -Donation expense

Worked example: Disposal at different dates

Worked example: Complete journal entries

Recording in financial statements

The disposal of a fixed asset affects both the Balance Sheet and the Income Statement.

Note to the Balance Sheet

Fixed assets are usually shown in a note to the financial statements, which provides detailed information about movements in fixed assets during the year. This note includes:

• Cost price at the beginning of the year
• Accumulated depreciation at the beginning of the year
• Carrying value at the beginning of the year
• Movements during the year (additions, disposals, depreciation)
• Cost price at the end of the year
• Accumulated depreciation at the end of the year
• Carrying value at the end of the year

The asset disposal is shown as a movement that reduces both the cost price and accumulated depreciation by their respective amounts.

Asset register

Businesses maintain an asset register for each individual asset. This register tracks:

• Asset identification details (number, description)
• Date of purchase
• Cost price
• Depreciation method and rate
• Annual depreciation for each year
• Accumulated depreciation
• Carrying value
• Details of disposal (if applicable)

When an asset is disposed of, the register is updated to show:

• The date of disposal
• The amount received
• The profit or loss on disposal

This creates a permanent record of the asset's history with the business.

Exam tips

When answering questions about asset disposal:

1. Always start by calculating the carrying value - you cannot determine profit or loss without it

2. Check the disposal date carefully - if it's mid-year, you must calculate pro rata depreciation

3. Show all your workings - examiners award marks for the correct method, even if your final answer is slightly wrong

4. Remember the order of journal entries - cost first, then accumulated depreciation, then proceeds, finally profit/loss

5. Check that Asset disposal balances to zero - if it doesn't, you've made an error

6. Pay attention to the disposal method - cash, credit, trade-in, withdrawal, and donation each require different entries

7. Use the accounting equation to check your work - total debits must equal total credits

Remember!