Selling Assets With Residual Value
In order for a business to carry out its activities satisfactorily, the business needs resources to facilitate this. The resources the business uses to generate revenues are known as assets. Examples of assets include property, the physical plant, cash and equipment. Assets further classify into current or fixed. Current assets include cash and any asset that can quickly convert to cash, such as stocks or debts to the company. Fixed assets are those resources a business uses for long periods of time, and cannot quickly convert into cash. Fixed assets further classify as tangible or intangible. Tangible assets include land, buildings, machinery, motor vehicles and fixtures. Intangible assets include trademarks, customer goodwill and patents. The concept of residual value comes into play when a business wants to sell a fixed asset.
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Residual Value
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Fixed assets deteriorate in value due to continued usage and must frequently undergo maintenance to keep them in good working order. However, it reaches a point when a business can no longer derive benefit from the asset due to this depreciation. At this point, the business may decide to sell off or dispose of such an asset. At this time, the business needs to estimate the value of the asset’s deterioration. This is then set off against the amount spent in acquiring the asset in order to determine the asset’s residual value. Intangible assets usually have a nil residual value. For example, a patent has zero value after its expiration. For leased assets, the business calculates residual value by subtracting payments made throughout the lease’s life from the asset cost.
Residual Value in Selling Assets
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Assets with some value remaining after a business nets off depreciation may return a profit or generate a loss on disposal. If the selling price is higher than residual value during disposal, the difference is a gain. When a business sells an asset for a lower price than the residual value, the difference is a loss.
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Accounting Entries for Asset Disposal
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The business writes off the total depreciation to date in the accumulated depreciation account and credits the amount on the asset disposal account. The business then writes off the initial cost of the asset in an asset account, such as the equipment account. This amount transfers to the debit side of the asset disposal account, which the business opens for this purpose. The accounting also reflects double entry for cash proceeds. The company’s income statement at the end of the period must record the gain or loss on the sale of assets.
Example
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Company A had purchased equipment at a cost of $2 million. After 5 years, the estimated residual value is $200,000 after charging depreciation at $360,000 per year. If Company A sells the asset for $500,000 at the end of 5 years, this leads to a gain of $300,000. If the company sells the same asset for $100,000, it would realize a loss at disposal of $100,000.
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