Question

Discuss gains/losses on sale of equipment in view of investors’ assessment of these gains/losses (i.e., economic gains/losses) in relation with previous depreciation expenses of the equipment

Answer 1

Equipments also known as non-current or tangible assets, are long range assets whose cost can be measured reliably.

The equipment’s cost is calculated by adding the item’s purchase price, or historical cost, to the other costs related to acquiring the asset. These additional costs can include import duties and deductible trade discounts and rebates.

Historical cost also includes delivery and installation of the asset, as well as the dismantling and removal of the asset when it is no longer in service. Equipment is subject to depreciation. Depreciation is a periodic reduction in an asset’s value. It is disclosed on the income statement and appears as a contra-asset account on the balance sheet.

Since accounting standards state that an asset should be carried at the net book value, equipment is listed on the balance sheet at its historical cost amount. The cost is then reduced by accumulated depreciation to arrive at a net carrying value or net book value. A company is free to decide what depreciation method to use on the equipment.

When an equipment is sold, the sale of the asset can trigger a gain or a loss, depending on the difference between the equipment’s net book value and its sale price. As with other assets, gain or losses on sales of equipment are disclosed on the income statement as a reduction or addition to income for the period.

Eg:

If investor acquires equipment with a total cost of ₹1,00,000 with a 9-year life. He/she applies depreciation of ₹10,000 every year.

Then,

Net book value after 9 years would be ₹10,000. ( ₹1,00,000 - ₹ 90,000)

If investor sell this equipment for ₹15,000 in the market after 9 years of usage then, he/she makes a gain of ₹5,000.

i.e. Gain/loss on sale of asset = selling price of asset – net book value of asset
(15,000 – 10,000 = 5,000)

But,
If investor sell this equipment for ₹5,000 in the market after 9 years of usage then, he/she makes a loss of ₹5,000.

i.e. Gain/loss on sale of asset = selling price of asset – net book value of asset
(5,000 – 10,000 = -5,000).

Therefore, Gain/loss on sale of equipment from investors point of view depends upon difference between the equipment’s net book value and its sale price. This gain/loss on sale equipment will be reflected on the income statement as a reduction or addition to income for the period thus impacting profit and profit margin.