How to calculate profit or loss on disposal

Step by step

1. Open a disposal account. Transfer the asset's cost to the debit of the disposal account.
2. Remove the accumulated depreciation. Credit the disposal account with the total depreciation charged to date on the asset.
3. Enter the sale proceeds. Credit the disposal account with the amount received on sale.
4. Balance the account. A credit balance is a profit on disposal. A debit balance is a loss.
5. Take the result to the income statement. A profit on disposal is income. A loss on disposal is an expense.

Worked example

Cost RM20,000, depreciation RM14,000 (carrying amount RM6,000), sold for RM7,000. The profit on disposal is RM1,000.

Understanding the method

While an asset is in use, it sits in the books at its carrying amount (net book value). This is cost less all the depreciation charged so far. A profit or loss on disposal is the gap between that figure and what the asset actually sells for.

If it sells for more than the carrying amount, too much depreciation was charged in earlier years, and a profit appears. If it sells for less, too little was charged, and a loss appears.

The result corrects earlier depreciation estimates. It is not a trading gain.

The disposal account does three jobs. It takes the asset's cost out of the non-current asset account. It removes the accumulated depreciation that belonged to that one asset.

And it brings in the proceeds. What balances the account is the profit or loss.

Questions may give the carrying amount directly, so you compare it with the proceeds straight away. A trade-in allowance on a new asset counts as proceeds, even though no cash changes hands. Check the depreciation policy for the year of disposal, because it changes the accumulated figure and so the result.

Here is an example. A delivery van cost RM48,000. Accumulated depreciation at the disposal date is RM33,000, so the carrying amount is RM15,000.

The supplier allows RM11,000 in part-exchange for it. Proceeds of RM11,000 are below RM15,000, so the loss on disposal is RM4,000. If the allowance had been RM17,000, there would be a profit of RM2,000.

To check, proceeds minus carrying amount equals profit, and a negative answer is a loss. Once the disposal is complete, the asset account and the provision for depreciation account should show nothing for the sold asset. If either still does, a transfer was missed.

Sense-check the sign too. A nearly new asset sold cheaply should give a loss. A fully written-down asset sold for anything should give a profit.

Common mistakes: transferring all of the business's accumulated depreciation instead of the amount for the asset sold, and netting the profit or loss against the proceeds. Others are treating a part-exchange as if the old asset earned nothing, and charging depreciation in the year of sale when the policy does not. Some also present the profit as sales revenue.

If disposal accounts leave you unsure whether you have a profit or a loss, we can help. One of our teachers can walk through a few disposals with you and check your workings. Book a trial class

Related skills

• How to calculate depreciation (reducing balance method)
• How to calculate depreciation (straight-line method)
• How to write a journal entry

The methods here are standard accounting practice, with original figures. For your exam board's exact requirements, see exam boards and Sources.