What it means
Fixed assets such as vehicles, machinery and equipment are recorded at cost and then written down each year through depreciation. The figure left on the balance sheet is the carrying amount, also called net book value.
When the asset is sold, the sale price is compared with the carrying amount. If the proceeds are lower than the carrying amount, the difference is a loss, and if higher it is a gain.
The loss is shown in the profit and loss account, often within other operating expenses. The asset's original cost and its accumulated depreciation are both removed from the balance sheet at the time of sale.
A loss on disposal usually means that depreciation did not keep pace with the asset's true decline in value. Perhaps the asset was used more heavily than expected, became obsolete or was damaged.
It does not mean cash was lost on the sale, because the cash was spent when the asset was bought. Analysts often treat such losses as non-recurring and adjust them out when judging underlying performance.
But repeated losses on disposal can signal that useful lives or residual values are set too optimistically. If so, the depreciation charges in earlier years were too low and profit was overstated.
Tax treatment differs by country. Some tax systems allow the loss to reduce taxable profit, while others handle it through balancing allowances or limit the way it can be used.
The accounting entry and the tax effect should be considered separately. Related events deserve separate thought.
When an asset is classified as held for sale, depreciation stops and it is measured at the lower of its carrying amount and fair value less costs to sell. That can bring the loss forward to the date the decision to sell is made, before any buyer is found.
In practice
Real-world examples
Example 1
A delivery company sells a five-year-old van for $9,000. Its net book value was $12,500. The company records a $3,500 loss on disposal, and the finance team reviews whether its useful life estimate for vans is too long.
Example 2
A printing business replaces an old press that has become obsolete because customers want digital printing. It scraps the press for nothing, and the remaining book value of $22,000 is written off as a loss. The loss is shown separately in the management accounts so the board can see it was a one-off.
Example 3
A hospital group sells a scanner to a smaller clinic for $140,000. The scanner was carried at $150,000. It records a loss of $10,000 and uses the cash to help fund a replacement.
Think of it
Imagine buying a used car for ten thousand pounds, estimating it will be worth four thousand pounds after three years. If you sell it after three years for only two thousand five hundred pounds, you take a loss on the sale because reality fell short of your estimate.
Formula
Calculation
Loss on disposal = Net book value - Sale proceeds
Net book value = Original cost - Accumulated depreciation
A company bought a machine for $100,000 and has recorded $65,000 of accumulated depreciation, so the net book value is 100,000 - 65,000 = $35,000. It sells the machine for $28,000. The loss on disposal is 35,000 - 28,000 = $7,000. The entry removes the $100,000 cost and the $65,000 depreciation, records $28,000 cash and charges the $7,000 loss to the profit and loss account.Case study
Seen in the real world
Stratford Print Works is an illustrative, fictional printer that decided to close one of its two plants. The equipment in the closing plant had a net book value of $1,400,000, but a buyer offered only $900,000 for the lot. The owner was surprised that the sale would cause a loss on the accounts.
The finance director explained that the loss of $500,000 reflected the machines being worth less than the depreciated cost recorded, not new cash leaving the business. She showed the board that the sale still brought in $900,000 of cash to repay a loan. The board accepted the sale and agreed to review useful lives across the remaining equipment to avoid similar surprises.
Watch out
Common mistakes
- Treating a loss on disposal as a cash loss, when it is the difference between the book value and the proceeds.
- Comparing the sale price with the original cost instead of the net book value.
- Forgetting to stop depreciating the asset at the date it is sold or classified as held for sale.
Questions
People also ask
Where does a loss on disposal appear in the financial statements?
In the profit and loss account, usually within other operating expenses or a separate line, and the asset is removed from the balance sheet.
Does a loss on disposal reduce tax?
In many countries it can reduce taxable profit, but the rules vary, so the tax treatment should be checked locally.
What causes a loss on disposal?
Selling an asset for less than its carrying amount, typically because depreciation was too slow, the asset became obsolete or market prices fell.