When fixed assets are sold, by definition, money is, or will be received. The result is entries to Cash or Accounts Receivable. You must also make entries to remove the Asset from the books and to remove any Accumulated Depreciation on the books for that Asset. The result is that the sum of the debits will not equal the credits in this transaction. The account that will be used to balance the debits and credits is called Gain on Disposition of Fixed Assets. The following example will help explain these entries.
Consider a machine is originally purchased for $10,000 and is depreciated for 5 years using the straight-line method with $0 salvage value. After 2 years the entries in the Ledger would look like this:
Equipment – Machine A | Accumulated Depreciation | |||
$10,000 | $2,000 (yr 1) | |||
$2,000 (yr 2) | ||||
Now you decide to sell the machine for $8,000. You will make entries that zero-out the Equipment and Accumulated Depreciation accounts (since they will no longer exist) and you must also account for the Cash or Accounts Receivable you now have due to the sale. These Journal entries will look like this:
Dr. Cash $8,000
Dr. Accumulated Depreciation 4,000
Cr. Equipment – Machine A $10,000
$12,000 $10,000
But you will notice that the Debits and Credits do not match. This is corrected by using an account called Gain (Loss) on the Disposition of Assets or similar. A Debit entry is a Loss (like an Expense) and a Credit entry is a Gain (like a Revenue). In this case there will be a $2,000 Credit entry as shown below:
Dr. Cash $8,000
Dr. Accumulated Depreciation 4,000
Cr. Equipment – Machine A $10,000
Cr. Gain (Loss) on Disposition $2,000
$12,000 $12,000
Now debits and credits balance!
How does this transaction affect the Cash Flow Statement. You will notice that the total value of Fixed Assets will be reduced on the Balance Sheet (a Source of Cash) and you have increased the Cash account. These account for the cash flows from the transaction.