A company uses the composite depreciation method for a group of dissimilar machines, applying a single composite depreciation rate to the group's total cost rather than tracking each machine's accumulated depreciation individually. One machine in the group, with an original cost of $50,000, is sold during the year for $12,000 cash. Under US GAAP, how should the company record this retirement?
- Debit Cash for $12,000, debit Loss on Disposal for $38,000, and credit the asset account for $50,000, recognizing the full shortfall between the sale proceeds and original cost as a loss in earnings
- Debit Cash for $12,000 and credit Gain on Disposal for $12,000, since composite depreciation defers gain recognition on individual retirements until the entire asset group is eventually retired
- Debit Cash for $12,000, debit the asset account for the machine's individually tracked accumulated depreciation, and credit the asset account for $50,000, computing and recognizing whatever gain or loss results from comparing proceeds to the machine's own carrying amount
- Debit Cash for $12,000, debit Accumulated Depreciation for the $38,000 difference between the machine's $50,000 cost and the cash received, and credit the asset account for the full $50,000 cost, recognizing no gain or loss on the retirement
Why D? And why not the others?
Correct answer: D. Debit Cash for $12,000, debit Accumulated Depreciation for the $38,000 difference between the machine's $50,000 cost and the cash received, and credit the asset account for the full $50,000 cost, recognizing no gain or loss on the retirement
Under the composite (or group) depreciation method, individual assets within the group do not have their own separately tracked accumulated depreciation, because the method deliberately depreciates the pooled cost of dissimilar assets at one blended rate to simplify recordkeeping and smooth out over- or under-depreciation across the group. When an individual asset is retired in the ordinary course, US GAAP practice for this method removes the asset's full original cost from the asset account, records the cash or other consideration received, and plugs any difference to Accumulated Depreciation, recognizing no gain or loss in earnings on the retirement — here, Cash for $12,000, Accumulated Depreciation for the $38,000 difference, and the asset account credited for the full $50,000. Recognizing a $38,000 loss in earnings improperly applies individual-asset retirement accounting to a method that is specifically designed to avoid that outcome for ordinary dispositions. Recognizing a $12,000 gain equal to the cash received is not how any disposal is recorded under any depreciation method. Tracking the machine's own individual accumulated depreciation and computing a gain or loss from it contradicts the entire premise of the composite method, which pools rather than individually tracks depreciation across the group's dissimilar assets.
Source: US GAAP practice guidance on group and composite depreciation methods (e.g., PwC's Property, Plant and Equipment guide, chapter on depreciation): no gain or loss is recognized on ordinary retirements, with the cost/proceeds difference absorbed by accumulated depreciation