What Happens to Depreciation When an Asset Is Sold?
The accounting for capitalized assets is confusing at times, but getting a better grip on it will help you better understand financial statements. There are many steps in the accounting for capitalized assets, including depreciating the asset and the depreciation schedule. Confusion can arise concerning depreciation when the asset is sold.
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Depreciation
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Depreciation is an accounting term for calculating expenses over a period of time. Certain assets that are capitalized on the balance sheet are subject to depreciation.One such asset is equipment. Equipment expense is calculated over a period of time allowed by the Generally Accepted Accounting Principles (GAAP). Different fixed assets have different useful lives and therefore have different depreciation schedules.
Accumulated Depreciation
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Accumulated depreciation is a contra asset account a company has on the balance sheet. The purpose of a contra asset account is to lower the value of assets. The accumulated depreciation account of an asset is the running cumulative total of depreciation a company has taken to date on the item. If, for example, a company bought equipment two years ago for $5 million and took $1 million depreciation for year one and year two, the accumulated depreciation account for the equipment would be $1 million plus $1 million for a total of $2 million.
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Asset Sold
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When an asset is sold, the book value of the asset, or just the amount it was bought for minus the accumulated depreciation, serves as the cost for accounting purposes. If the company sells the equipment for more than the book value, the company records a gain. If the company sells the equipment for less than book value, the company records a loss. Once the asset is sold, the cost of the asset and the depreciation of the asset are wiped off the books so there is no value on the balance sheet due to the equipment.
Example
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A company has an asset that it bought for $5 million and has $3 million of accumulated depreciation on the asset for a book value of $2 million. The company sells the asset for $2 million in cash so the company does not record a gain or a loss. The asset the company sold is completely wiped off the books so the value of the equipment account falls by $5 million and the value of the accumulated depreciation account falls by $3 million.
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