This resource explains the important accounting and tax implications of disposing of business assets, specifically focusing on the concept of “balancing adjustments” as outlined by Australian Taxation Office (ATO) guidelines.
What is a Balancing Adjustment?
A balancing adjustment occurs when a business sells, loses, or disposes of an asset they’ve claimed depreciation on. Depreciation refers to the deduction businesses claim each year as the value of an asset reduces over time. When you dispose of this asset, you need to calculate if there’s a difference between its value at disposal (termination value) and its value in your accounts (written down value or undeducted cost).
The Australian Bookkeepers Network explains clearly:
“Essentially, therefore, where an item of plant is disposed and you have claimed depreciation on that plant during its life, you need to compare the termination value (e.g., sale proceeds) with the plant’s written down value or undeducted cost at the time of disposal”.
Key Terms Explained:
- Termination Value: This is typically the sale price minus any selling costs.
- Written Down Value: Original cost of the asset, minus all depreciation you’ve already claimed.
- Undeducted Cost: The original cost minus depreciation you could have claimed if the asset was always used for income-generating activities.
When Do Balancing Adjustments Happen?
Balancing adjustments typically happen when:
- You sell an asset.
- An asset is destroyed or lost.
- There’s a compulsory acquisition (forced sale) by the government.
These events require adjustments because they directly affect your asset’s accounting value.
Calculating Balancing Adjustments (No Private Use):
Consider this practical example:
Example:
Darren’s business purchased equipment for $6,000, depreciating at 25% per year. After three years, he sells the equipment for $1,800.
Date | Description | Amount ($) |
30 June 2012 | Purchase cost | 6,000 |
30 June 2013 | Depreciation (25%) | -1,500 |
30 June 2014 | Depreciation (25%) | -1,125 |
30 June 2015 | Depreciation (25%) | -844 |
| Written Down Value at Sale | 2,531 |
| Termination (sale) Value | 1,800 |
The termination value ($1,800) is less than the written down value ($2,531), resulting in a balancing adjustment deduction of $731 ($2,531 – $1,800).
Impact of Private Use:
If the asset has private use (personal/non-business use), adjustments must be made.
Example:
Using the same example above, if Darren’s equipment had 10% private use:
- Actual depreciation claimed reduces (90% business use).
- The balancing adjustment deduction also reduces by 10%.
The balancing adjustment becomes:
- Undeducted Cost ($2,531) – Termination Value ($1,800) = $731
- Adjusted for business use (90%): $731 x 90% = $658 allowable deduction.
Assessable Balancing Adjustments (Profits on Disposal):
If the termination value exceeds the written down value, you must report this profit as income:
Example:
Darren sells the asset for $3,000 instead:
- Written down value: $2,531
- Termination value: $3,000
- Profit (Balancing Adjustment): $469 (assessable income)
This amount can’t exceed the total depreciation claimed. Since Darren’s total depreciation claim is greater ($3,469), the full $469 is assessable.
Further Balancing Adjustments (Selling Above Original Cost):
- Balancing adjustment: Total depreciation claimed ($3,469).
- Further adjustment: Sale proceeds ($6,500) – Original cost ($6,000) = $500 extra.
- Total assessable income: $3,969.
Involuntary Disposal (Destroyed or Lost Assets):
Special rules apply if an asset is lost, destroyed, or compulsorily acquired (e.g., government purchase):
- You can offset any balancing adjustment against the cost of replacement assets.
- No immediate income tax obligation if proceeds reinvested in similar assets.
Example (Factory Fire):
- Plant destroyed, insured for $18,000.
- Written down value: $8,000.
- Potential taxable balancing adjustment: $10,000.
- Replacement plant costs $24,000.
- Balancing adjustment ($10,000) offsets replacement plant cost, recorded at $14,000.
Accounting Entries for Balancing Adjustments:
- Asset sold at loss:
- Debit: Cash, Accumulated Depreciation
- Credit: Asset Cost, Loss on Disposal
- Asset sold at profit:
- Debit: Cash, Accumulated Depreciation
- Credit: Asset Cost, Gain on Disposal (assessable income)
Cross-check with the ATO:
According to the Australian Taxation Office, these balancing adjustment rules ensure taxpayers correctly account for gains or losses upon disposal. Depreciation claims during the asset’s life must be accurately balanced upon disposal, ensuring proper reporting on tax returns.
ATO Reference: Balancing Adjustments (ATO Website)
Key Takeaways:
- A balancing adjustment ensures accurate taxation upon asset disposal.
- Losses (where the asset sells for less than the written down value) may be deductible.
- Gains (selling above the written down value) are taxable.
- Special provisions apply to involuntary disposals, allowing balancing adjustments to offset replacement assets.
Understanding these concepts ensures accurate financial records and tax compliance, ultimately benefiting the financial health of your business.
