What is the Cost of Disposal in Accounting?
Understand how the costs to sell an asset are identified and applied, affecting balance sheet valuation and the final reported gain or loss on the transaction.
When a company sells a significant asset, such as a building or equipment, it incurs expenses directly related to that sale, known as costs of disposal. These are the incremental costs a company must pay to complete the transaction. Understanding these costs is important for a business to accurately determine the financial impact of selling an asset, as they directly reduce the gain or increase the loss recognized from the sale. This calculation also influences how the asset is valued on financial statements leading up to its disposition.
Components of Disposal Costs
The calculation of disposal costs involves identifying direct expenses that would not have been incurred if the company had not decided to sell the asset. These are incremental costs directly resulting from the sale. Common examples include brokerage commissions, which can range from 4% to 6% for real estate, and legal fees for drafting sales contracts. Other includable expenses are closing costs and title transfer fees required to legally pass ownership.
Certain expenditures are explicitly excluded from the cost of disposal calculation. For instance, any operating losses an asset generates while it is being marketed for sale cannot be included and are treated as normal operating expenses. Similarly, costs associated with reorganizing a business segment after the asset is sold or costs to terminate employees are accounted for separately under different accounting rules, such as those in ASC 420.
The principle guiding this classification is whether the cost is required for the transfer of title. Costs to physically move an asset to a buyer’s location after the sale is complete would be a direct cost of disposal. In contrast, expenses for repairs or maintenance performed to get the asset into a sellable condition are not included. These are considered part of the asset’s ongoing operational expenses or are factored into its fair value assessment.
Accounting for Assets Held for Sale
When management commits to a plan to sell an asset and it is available for immediate sale, its accounting treatment changes. Under U.S. Generally Accepted Accounting Principles (GAAP), specifically ASC 360, the asset is reclassified on the balance sheet as “held for sale.” This classification requires that the sale is probable, actively marketed, and expected to be completed within one year. Once an asset is classified as held for sale, the company stops recording depreciation or amortization on it.
An asset held for sale must be recorded at the lower of its carrying amount or its fair value less costs to sell. The carrying amount is the asset’s value on the books (original cost minus accumulated depreciation). Fair value is what the asset could be sold for in the open market. This valuation ensures the asset is not reported at an amount higher than what the company expects to realize from its sale.
This re-measurement can trigger an impairment loss. For example, a company has a machine with a carrying amount of $100,000. It determines the machine’s fair value is $90,000 and estimates the direct costs to sell it will be $5,000. The fair value less costs to sell is $85,000 ($90,000 – $5,000). Since $85,000 is lower than the $100,000 carrying amount, the company must write down the asset’s value to $85,000 and recognize a $15,000 impairment loss on its income statement.
Reporting Discontinued Operations
Sometimes, the sale of an asset or a group of assets represents a strategic shift that has a major effect on a company’s operations. When a disposal qualifies under the criteria in ASC 205-20, it is classified as a discontinued operation. This could be the sale of a major product line, a geographic market, or a significant subsidiary. This classification requires a special presentation on the income statement to provide clarity to investors about the performance of the company’s ongoing business.
The financial results of the component being sold are removed from the results of continuing operations and reported separately at the bottom of the income statement, net of their related income tax effects. This presentation consists of two distinct lines. The first line shows the income or loss from the component’s operations for the reporting period. The second line reports the gain or loss recognized on the disposal of the component.
This segregated reporting allows financial statement users to distinguish between the profitability of the core, continuing business and the financial impact of the divested component. For example, the income statement would first show “Income from continuing operations,” and then below that, a section titled “Discontinued operations” would display the two specified lines. This ensures the sale does not distort the perception of the company’s sustainable earnings power.