Question

Describe the GAAP rules for when a firm scraps or abandons PPE including how any gains and losses are calculated.

Answer 1

Definition Of PPE:

• Tangible assets held for use in production or supply of goods or services or for rental purpose or for administrative purpose and
• Expected to be used more than one period

Initial Recognition:

PP&E are supposed to be recorded at Cost. However, there are two exceptions where they are recorded at Fair Value:

• Acquired in exchange for Non-Monetary Asset.
• Acquired in Business Combination.

Retirement and Disposals:

When an asset is permanently withdrawn for use or sold/scrapped, and no future economic benefits are expected, then it should be withdrawn from PP&E.

Gains or Losses on disposal should be recognized in P&L as income/expense. An entity cannot classify gain as revenue on disposal of specific item of PP&E.

Definition of Gain or Loss on Sale of an Asset

The gain or loss on the sale of an asset used in a business is the difference between 1) the amount of cash that a company receives, and 2) the asset's book value (carrying value) at the time of the sale.

In order to know the asset's book value at the time of the sale, the depreciation expense for the asset must be recorded right up to the date that the asset is sold.

If the cash received is greater than the asset's book value, the difference is recorded as a gain. If the cash received is less than the asset's book value, the difference is recorded as a loss.