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Many businesses find the need to sell, destroy or donate capital assets as a part of their regular investment activities. The reasons for disposal of a capital asset vary -- some are interested in raising cash to finance operations, others are simply replacing assets that have outlived their useful life. Whatever the reason for a capital asset disposal, good business practice requires the company to follow generally accepted accounting principles (GAAP) when recording these transactions.
Disposal of a Capital Asset
Any long-term asset that a company purchases for a business purpose -- such as land, a factory, equipment or even shares of another business -- is called a capital asset. When the business somehow gets rid of a capital asset, the related accounting transaction is called the disposal of this capital asset, even if the business does not actually throw the asset away as garbage. Most businesses dispose of a capital asset through sales, and account for any gain or loss realized on this sale as either a source of income or a business expense. Assets are rarely disposed of at their exact recorded value or book value, on the company's balance sheet
Depreciation and Book Value
When most capital assets are used, they often lose value to depreciation -- the difference between their cost when the business purchases them and the amount they're expected to be worth at their disposal. Because the business technically loses money as a result of depreciation, companies must adjust the value of their assets periodically to account for this cumulative expense. The asset's original value minus the total amount lost to depreciation is the asset's book value -- the amount the asset is worth according to the company's records. When the asset is disposed, GAAP requires that they again adjust the value to account for any difference between book value and the asset's actual value at sale or disposal.
Asset impairment is a situation that exists when the asset's book value exceeds the asset's fair market value, and is unrecoverable. An impaired asset is expected to realize a loss at disposal as a result. GAAP requires businesses to recognize an impairment at significant events, such as major changes in market conditions, expectations regarding disposal or regulatory developments. When an impairment is recognized under GAAP, the business must report the event as a capital loss even if the asset is not disposed of immediately.
The disposal of capital assets under GAAP has some significant taxation implications. This is because any gains realized on an asset are taxable as capital gains -- a kind of investment income. In addition, businesses are allowed to deduct from their income any expenses resulting from a capital asset loss. For these reasons, businesses sometimes try to strategically dispose of capital assets in a way that minimizes tax expenses. This practice is allowed under GAAP as long as the business properly records the transaction.