Asset Disposal and Statement of Cash Flows

Reece Company purchased a truck on January 1, 1993, for \$25,000. The truck has a useful life of 5 years and an estimated salvage value of \$5,000. Marsh Company uses straight-line depreciation for all of its plant assets. For each of the following independent assumptions, show the effects to the accounting equation to record the sale of the truck and show how the effects of depreciation and the sale of the truck would be reported on the statement of cash flows prepared using the indirect method for the year ended December 31, 1995.

• On December 31, 1995, Marsh sold the truck for \$15,400.

• On December 31, 1995, Marsh sold the truck for \$4,200.

solution

How do I get there?

You will calculate the gain or loss on a sale of a property, plant and equipment asset by comparing the selling price to the book value at the time of sale. You will prepare the accounting equation showing the effects and show how the effects of depreciation appear on the statement of cash flows.

Step One

Calculate the amount of depreciation expense per year and multiply it by the number of years since the truck was purchased to determine the amount of accumulated depreciation at December 31, 1995:

(Cost - Salvage Value) / Useful Life = (\$25,000 - \$5,000)/5 = \$4,000

\$4,000 x 3 = \$12,000

Step Two

Calculate the book value at the time of sale by subtracting the accumulated deprecation from the original cost:
 Cost \$   25,000 Less accumulated depreciation 12,000 Book value \$  13,000

Step Three

Calculate the gain or loss on the sale of the truck by subtracting the book value from the selling price of the truck:

 Sold for \$15,400 Sold for \$4,200 Selling price \$15,400 \$  4,200 Book value 13,000 13,000 Gain (loss) \$  2,400 (\$8,800)

Step Four

Show the effects on the accounting equation to record the sale under each circumstance:

If sold for \$15,400:

Dec. 31 Record sale of truck
Cash account increases by 15,400, the Accumulated Depreciation account would show an increase of 12,000 because we are taking the depreciation associated with the truck out of the account, Gain on Sale of Truck would be an increase of 2,400, and the asset account Truck would be decreased by 25,000.

 Assets Liabilities Contributed Capital Retained Earnings +15,400 Cash +2,400 Gain on Sale +12,000 Acc. Depr. (25,000) Truck

If sold for \$4,200:

Dec. 31 Record sale of truck.

Cash is increased by 4,200, Accumulated Depreciation is an increase for the amount of 12,000 because we must take the depreciation associated with the truck out, Loss on Sale of Truck is a decrease of 8,800, and the Truck account is a decrease of 25,000 to take it off of the books.

 Assets Liabilities Contributed Capital Retained Earnings +4,200 Cash (8,800) Loss on Sale +12,000 Acc. Depr. (25,000) Truck

Step Five

Show how the effects of the sale would be reported on a statement of cash flows prepared using the indirect method. The indirect method begins with net income. Since the effect of a gain is an increase in net income and a loss is a decrease in net income, you will subtract a gain and add a loss in the operating activities section. The cash received from the sale is reported as an investing activity. Since the cash was received, this amount is added in determining cash flows from investing activities.

 If sold for a loss: Cash flows from operating activities: Net Income \$        xxx Add loss from sale of truck + 8,800 Cash flows from investing activities: Sale of truck \$   4,200 If sold for a gain: Cash flows from operating activities: Net Income \$        xxx Subtract gain from sale of truck (2,400) Cash flows from investing activities: Sale of truck \$ 15,400

Tips

When recording the sale of an asset, remove the original cost (ignore salvage value) and remove the total amount of accumulated depreciation from the respective accounts.