Financial Management: Core Concepts, Third Edition

10.4 Cash Flow and the Disposal of Capital Equipment

When we sell a depreciable asset, we calculate a tax gain or tax loss, which we base on the asset’s book value at the time of disposal. If there is a gain, we must pay taxes, and we have a cash outflow. If there is a loss, we record a tax credit or tax reduction, and we have a cash inflow. We want to identify those assets that the company sells from a specific project so that we can properly include the cash flow in the decision to accept or reject that project.

The asset’s current book value serves as the basis for determining the gain or loss at disposal. Book value is the asset’s original cost minus the accumulated depreciation. We recognize a gain on disposal when the asset’s selling price ...