Understanding Fully Depreciated Fixed Assets: An In-Depth Accounting Tutorial

When it comes to accounting for fixed assets, the process involves several steps. One critical aspect that every accounting student must understand is how to handle fully depreciated fixed assets. A fully depreciated asset is one whose book value has reached zero due to the depreciation charged over its useful life. But the question remains: how do you record and manage these assets once they’ve been fully depreciated?

In this tutorial, we will break down the concepts of fully depreciated fixed assets, walk through journal entries, explore the impact on financial statements, and give you a series of practice questions to consolidate your learning.

What Does “Fully Depreciated” Mean?

To begin, let’s define the term “fully depreciated.” Fixed assets like machinery, vehicles, or office equipment are depreciated over their useful lives to spread the cost of the asset over time. Depreciation is a non-cash expense that reduces the asset’s value on the balance sheet and reflects its gradual decrease in value due to wear and tear or obsolescence.

When an asset is fully depreciated, it means that the accumulated depreciation equals the asset’s original cost. For example, if you purchased a machine for $10,000 and depreciated it by $1,000 each year for 10 years, the asset would be fully depreciated after 10 years, with an accumulated depreciation of $10,000.

At this point, the book value of the asset is zero, but it may still have useful life and remain in operation. The accounting treatment of such assets can vary depending on whether the asset is still in use or has been disposed of.

Recording a Fully Depreciated Asset in the Books

When an asset is fully depreciated, its book value is zero, but it may still appear in the company’s financial records. Here’s how to manage this in accounting.

Let’s consider an example:

Example 1:

• Company XYZ purchased a piece of machinery for $5,000.
• The machinery has a useful life of 5 years.
• The company uses straight-line depreciation.

The annual depreciation would be:

• $5,000 ÷ 5 years = $1,000 per year.

After 5 years, the accumulated depreciation on the machinery will be $5,000, making the asset fully depreciated.

Now, the machinery still exists in the business but its book value is zero. Let’s see how we handle this in the books.

Journal Entry for Recording Depreciation

During each year of depreciation, we would make the following journal entry to account for the depreciation expense:

At the end of Year 5, the machinery is fully depreciated. It still appears on the balance sheet at its original cost of $5,000, but the accumulated depreciation will match this cost, bringing its net book value to zero.

The Impact on Financial Statements

When an asset is fully depreciated, it may still be in use, and its book value is now zero. Let’s explore how this impacts the company’s financial statements.

Income Statement:

The depreciation expense continues to be recorded each year as an expense on the income statement. This reduces taxable income, even though the asset has reached its fully depreciated state. The expense appears in the “Depreciation” line under operating expenses.

Balance Sheet:

Although the asset is fully depreciated, it is still listed on the balance sheet under “Fixed Assets.” However, the “Accumulated Depreciation” contra-asset account is adjusted accordingly, which will net the asset’s value to zero. The asset remains in the records until it is disposed of, sold, or written off.

What Happens When You Dispose of a Fully Depreciated Asset?

If the fully depreciated asset is still in use but is no longer needed, it may be sold, scrapped, or written off. If the asset is sold for an amount greater than its book value (which is zero after full depreciation), you’ll record a gain on disposal. If the asset is scrapped or written off, no gain or loss is recorded.

Example 2: Sale of Fully Depreciated Asset

Let’s say the machinery from the previous example is sold for $1,000. The journal entry would look like this:

Here, the asset is removed from the books, and the accumulated depreciation is cleared. The difference between the sale price and the asset’s book value (which is zero) is recorded as a gain.

Example 3: Scrapping a Fully Depreciated Asset

If the asset is scrapped, there’s no sale, and the journal entry would be:

This clears both the asset and the accumulated depreciation from the balance sheet. There is no gain or loss because the asset’s book value was already zero.

Practice Questions

Now that you have a solid understanding of how to handle fully depreciated fixed assets, let’s test your knowledge with some practice questions.

Question 1:

Company A purchased a computer for $2,000. The computer has a useful life of 4 years and is depreciated using the straight-line method. After 4 years, the asset is fully depreciated. What is the journal entry for the first year’s depreciation?

Answer:

The first year’s depreciation journal entry would be:

Question 2:

Company B sells a fully depreciated vehicle (original cost $8,000) for $2,000. What is the journal entry to record the sale of the asset?

Answer:

The journal entry would be:

Question 3:

Company C decides to write off a fully depreciated asset that is no longer in use. The asset had an original cost of $4,000, and its accumulated depreciation is also $4,000. What is the journal entry to remove the asset from the books?

Answer:

The journal entry would be:

Conclusion

Handling fully depreciated fixed assets is a key concept in accounting, and it’s essential for students to understand how to record, manage, and dispose of these assets. Whether the asset is still in use, sold, or scrapped, the accounting process remains systematic and structured, ensuring that financial statements reflect the true value of the business’s assets. By practicing the journal entries and understanding the impact on financial statements, you can confidently navigate the complexities of fixed asset accounting.