Selling fixed assets -- top line revenue or gain/loss "Other income"

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Selling Fixed Assets Gain Or Loss Accounting Treatment Discussion

Hypothetical #1 -- say a company is in the business of making auto wheel rims and uses lathes in the manufacturing process. If they sell off a used lathe, then I have always considered that as a sale of fixed assets, and the difference between sale proceeds and the FA NBV is a gain/loss on sale of asset -- usually some kind of "other income".

Hypothetical #2 -- a company is in a business relating to speciality scientific equipment. They sell, rent, repair, and provide in-field services using skilled labor and some of the specialty equipment. They do not manufacture. So they usually buy the equipment as fixed assets (for rent or for in field services), as well as buy some specifically to resell at a profit (those are usually accounted for as a quick buy/sell, or left in inventory for a month or two until sold). However, this company often, and with little identity control, also sells off rental assets or field service equipment if a customer asks for a deal.

Since the "sale of scientific equipment" is part of their ongoing business model and objective, are these fixed assets sales now "Revenues/COGS", or still "Other income" as a gain/loss on disposal? I would argue it goes into revenues, since "sales of equipment" is a key business objective. Does it really matter if it went into fixed assets or inventory first -- I say no, but I welcome support or counter arguments.

We are not CPA-reviewed or audited, but the bank requires "GAAP" financials.

Just to make my life more complicated, this real world client of mine also removes small to major parts of one piece of equipment and puts it on other fixed asset items to enhance or repair them, or may sell a removeable part of the equipment, say a camera head. No good tracking system for that process -- so the accounting? Don't ask! By the way -- these aren't cheap items -- $10,000 to $50,000 a piece.

Comments for/against or pointers to definitive GAAP on this are welcomed. (Maybe I should ask, what do Avis and Hertz do with their rental car fleet at point of purchase and later at time of used sale?)

Answers

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In addition to the great insights below, I also found this robust discussion of accounting for selling fixed assets:

http://www.proformative.com/questions/when-fixed-assets-are-sold-there-no-change-total-assets-figure-could-anybody-demystify

I hope it helps!

Best... Sarah

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Answering Hypothetical #1

Your question could have a larger than expected answer or a quick answer. I will frame an answer and if any of the assumptions do not fit your situation, then you will need additional depth of answer to match your set of facts and circumstances.

The Quick Answer - Go directly to the bottom of the summary.

GAAP Analysis - Read all, then do additional research on your own.

Assumptions about this answer:

- assumes the lathe in question is a single piece of equipment and not part of a planned disposal group of assets.
- assumes the lathe is NOT specific to a particular customer's long term manufacturing supply arrangement.
- assumes that you took the lathe out of manufacturing production to await sale at the point a new lathe was acquired and installed.
- assumes there is a period of time that elapses between de-installation and sale.

***Based on paraphrase from Wiley GAAP

An asset can be disposed of individually or as part of a disposal group. Disposal groups are beyond the scope of this discussion.

Here is how you determine if the asset should be reclassified on the Balance Sheet from "Held and Used" under PPE to "Held for Sale"

Six Criteria Must Be Met to Reclassify the Asset as "Held for Sale"

1. Management commits to a plan to sell the asset. (memorialized is best).
2. Asset is immediately available for sale on an "as is" basis.
3. Actively seeking a buyer for the asset, selling and advertising has commenced.
4. Unlikely that significant changes to the plan of sale will be made.
5. Sale of the asset is probable and recognition will occur within one year.
6. Asset is being actively marketed for sale at a price that is reasonable compared to its fair market value.

**If the criteria are met after the balance sheet date, say 12/31/2012, but prior to the issuance of the financial statements of 12/31/2012 say on 2/18/2013, then you would leave the asset classifed as "Held and Used" in PPE as normal, without reclassification to "Held for Sale" because the 6 factors would be complete in the period following the balance sheet date. As of the balance sheet date the asset is still PPE "Held and Used". If material, subsequent events disclosures would be required.

Assets "Held For Sale" are measured at the lower of...

A. The asset's carrying amount (In industry we say "net book value")

Or,

B. The fair value of the asset minus the costs to sell. (The asset is written up or down as needed to agree to its fair value minus costs to sell, and the adjustment is a gain or loss, materiality will decide if the gain/loss is separately stated. Any gains cannot exceed cumulative losses already recognized)

Selling Costs:

Costs that would not have been incurred if the sale was not transacted. borker commissions, legal, title, other, prior to the transfer of title.

What Happens If You Decide To Keep the Asset After It Has Been Reclassed to "Held for Sale"? Well most of what you did above would be reversed but that is beyond the scope of this answer.

Original Cost 1,200
AD at reclass (360)
Carrying amount 840 at reclass to Held for Sale
Monthly depr is 60

After reclass the fair value drops by 15 to 825.
After reclass selling costs accumulate to 15.

Journal Entries for Disposal By Sale of Asset "Held for Sale"

DR Equipment Held for Sale (net book value) 840
CR Equipment Held and Used (net, for simplicity) 840
(reclassify out of PPE to held for sale category)

Note that depreciation is suspended.

DR Loss on decline of fair value of equipment held for sale 15
CR Equipment Held for Sale 15
(Write down carrying value to lower of fair value minus selling costs)

DR Equipment Held for Sale 15
CR Recovery of fair value of Equipment Held for Sale 15
(recording additional disposition costs as time passes assuming costs go up)

Oops we decided that we would put it back into service because we didn't receive any offers, or some other decision was made not to sell. Note that there are accounting items in this scenario that are not discussed for sake of limited space.

DR Equipment Held and Used 840
CR Equipment Held for Sale 840 (Move it back to depreciable PPE Held and Used)

DR Depreciation expense 60
CR Accum depreciation 60
(record the catchup depreciation while it was classified as Held for Sale)

All of a sudden an unsolicited cash offer comes in a few months later!

Warning - don't check my math because it doesn't add up:

DR Cash 875
DR Accumulated Depreciation 460
CR Equipment Held and Used 1,200
CR Gain on equipment sale 135
(record gain on sale)

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In the event that you receive a cash offer or the sale of the Lathe is immaterial, the answer is the last journal entry above. Yes you will recognize gain or loss on the equipment Held and Used but Sold.

--------------------------

Note that this does not cover asset disposal by method "other than by a sale" such as an abandonment. I could go on but I will not. Please post another question if you need to understand Abandonment disposals.

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Answering the 3rd Part of Your Question:

"Spares" is the technical accounting term for this situation:

"Just to make my life more complicated, this real world client of mine also removes small to major parts of one piece of equipment and puts it on other fixed asset items to enhance or repair them, or may sell a removeable part of the equipment, say a camera head. No good tracking system for that process -- so the accounting? Don't ask! By the way -- these aren't cheap items -- $10,000 to $50,000 a piece."

Spares are capitalized and depreciated at the moment they are ready and available for use, regardless of when they might be considered placed into service.

The new IRS repair regulations discuss tax treatment for spares as well and essentially mimics this treatment.

I am from the Wireless industry and spares are a big part of the fixed asset puzzle. They get purchased and look like part of the self build inventory but are actually to be depreciated for book purposes when they are ready and available for use.

Here is where you might want to hire me to set up your fixed asset accounting procedures and train your team. Let me know.

Accounting for spares is difficult especially if you have a lot of install and decomissioning due to repairs and maintenance and warranty tracking. Its easy to get lost really fast. This is why companies set up asset tracking systems and bar code swipe everything.

If your spares are valued at 10K to 50K, these are not immaterial, and you will need to set up accounting policy and procedure and valuation guidelines around them. This includes instruction to purchasing about how to set up the PO and code through the system includes instruction to the shop as well about additional tracking for warranty returns etc. It gets very complex and the answer is beyond the scope of what I can help you with here.

The word you need for research is "Spares" or "Accounting for Spares."

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Hypothetical #2 -- a company is in a business relating to speciality scientific equipment. They sell, rent, repair, and provide in-field services using skilled labor and some of the specialty equipment. They do not manufacture. So they usually buy the equipment as fixed assets (for rent or for in field services), as well as buy some specifically to resell at a profit (those are usually accounted for as a quick buy/sell, or left in inventory for a month or two until sold). However, this company often, and with little identity control, also sells off rental assets or field service equipment if a customer asks for a deal.

Since the "sale of scientific equipment" is part of their ongoing business model and objective, are these fixed assets sales now "Revenues/COGS", or still "Other income" as a gain/loss on disposal? I would argue it goes into revenues, since "sales of equipment" is a key business objective. Does it really matter if it went into fixed assets or inventory first -- I say no, but I welcome support or counter arguments.

Answering Your Hypothetical #2

Yes - you will need to determine the revenue and cogs related to the sale of equipment. Ordinarily it would be ideal if you could separate the equipment being sold from the equipment being rented from the equipment being used in service delivery.

Next - you need to get a copy of the contract that specifies the terms of the deal. If the rented equipment is then sold at a point in time based on milestones or other criteria there may be a period of rental income and revenue from the sale. If there is rental income, the deal maybe an operating lease or a capital lease. If you are renting and during that time retain the economic benefits and risks of ownership then you will incur depreciation expense.

I cannot really give you a good answer because you have not provided all the details needed to unwind the scenario properly.

You might consider at this time hiring a CPA to act as your controller.

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Proformative Advisor
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Wow Valerie, that is certainly a thorough answer. Thanks, I really do appreciate all the time and effort you put into that. I did not mean it to get too overly complex.

This is a small company. Under $10mm revs and barely 10 employees, including one very low level accounting clerk. They have a monthly CPA visit to file state returns and post some entries -- but clearly they have not clarified this question. I am their 2-3 days a quarter CFO at most, helping the CEO on strategy and planning, and with the bank relationship.

Hypothetical #1 was just to set a comparative stance. I am already OK on what to do there, if that was our case. The core issue under #2 is whether we can definitely post the fixed asset sale into Revs/COGS as opposed to "Other income net gain/loss" given that the company does sell these kinds of items, new or used, as a key business line. i.e. it is probably a GAAP revenue recognition issue. The exact same equipment model may start out in fixed assets and be rented or used in the field for 6 months, then get sold. Or it may go via inventory as equipment held for resale (usually to an already identified customer). And no, there is no tracking in fixed assets of whether equipment is originally for rent, field service or possible later sale, and there never will be. It is all fungible stuff. That is my "internal control" dilemma, but that won't change at this company size.

I am sticking with post to revenues and COGS.

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On your hypothetical #2 you will need to review the contracts in combination with revenue recognition concepts for companies that sell goods and service or a combination of both. If you are working with lease agreements this will be more complex.

Ask the visiting CPA to review the transactions. If the CPA is from a firm they will have a library of resources to review and provide you with a best answer.

Many companies make the mistake of saying we are small so we don't need to worry about that. Eventually it will matter and it is always easier to establish a long term solution early so as things become more complex you have a better time of recognizing those developments early.

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