Wednesday, July 31, 2013

Gains and Losses on Disposition of Assets - Part I

Depreciable assets don't last forever. At some point, assets wear out and need to be replaced or become obsolete having outlived their usefulness. If assets have been depreciated down to zero dollars and the asset is dumped in a landfill, there is no gain or loss on the disposition of that asset. The book value is zero dollars and the market value (or real value) is zero dollars.

What happens though when the asset has not been fully depreciated and it is dumped? There is a loss on the disposition of that asset. Or what happens when it is sold for more than the book value? There is a gain on the disposition of that asset. There is a FAR cost principle (FAR 31.205-16) that deals with how gains and losses should be accounted for under Government contracts.

In short, the Government is going to share in either the gain or the loss when assets are disposed of. If there's a gain, the gain reduces the indirect expense pool for the year of disposal. If there's a loss, the loss increases the indirect expense pool for that year. Paragraph (a) of FAR 31.205-16 states:
Gains and losses from the sale, retirement, or other disposition of depreciable property shall be included in the year in which they occur as credits or charges to the cost grouping(s) in which the depreciation or amortization applicable to those assets was included. 
There are exceptions to this rule however. In the case of a business combination, no gain or loss shall be recognized as a result of the transfer of assets (more about this in FAR 31.205-52). Also, in the case of sales and leasebacks, there are some special rules that prevent the Government from paying more than they should - they'll accept the gain but won't absorb any of the loss:


  • when costs of depreciable property are subject to the sale and leaseback limitation in 31.205-11(h)1) or 31.205-38(b)(2)
    • The gain or loss is the difference between the net amount realized and the undepreciated balance of the asset on the date the contractor becomes a lessee, and
    • When the application of (b)(1) of this subsection results in a loss
      • The allowable portion of the loss is zero if the fair market value exceeds the undepreciated balance on the asset on the date the contractor becomes a lessee; and
      • The allowable portion of the loss is limited to the difference between the fair market value and the undepreciated balance of the asset on the date the contractor becomes a lessee if the fair market value is less than the undepreciated balance of the asset on the date the contractor becomes a lessee.


The FAR cost principle also includes guidance for calculating and applying gains and losses:
Gains and losses on disposition of tangible capital assets, including those acquired under capital leases shall be considered as adjustments of depreciation costs previously recognized. The gain or loss for each asset disposed of is the difference between the net amount realized, including insurance proceeds from involuntary conversions, and its undepreciated balance. The gain recognized for contract costing purposes shall be limited to the difference between the acquisition cost (or for assets acquired under a capital lease, the value at which the leased asset is capitalized) of the asset and its undepreciated balance (except see subdivision (c)(2)(i) of this section).
The gain recognized for contract costing purposes shall be limited to the difference between the acquisition costs (or for assets acquired under a capital lease, the value at which the leased asset is capitalized) of the asset and its undepreciated balance 
Tomorrow we will look at a special kind of asset disposition, involuntary conversions.


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