Definition
The term involuntary conversion refers to the unscheduled termination of property, plant, and equipment's service as the result of an unwanted event such as a fire, flood, or even theft. When the involuntary conversion of assets occurs, the company must compare the assets' original purchase price and accumulated depreciation to the disposition price to determine if there was a gain or loss on the conversion.
Explanation
One of the ways a company can dispose of assets is through an involuntary conversion, which can occur as a results of an unwanted event such as a fire, flood, or even theft. Companies can also dispose of assets through their voluntary sale or exchange.
When a company disposes of an asset, it must calculate the depreciation occurring between the last journal entry date and the date of retirement. The net book value is then determined by subtracting the total accumulated depreciation from the asset's historical cost. Net book value is then compared to the disposition price of the asset to determine if there was a gain or loss on the transaction. If the event involves a casualty loss, the net proceeds from insurance policies should be included in the calculation of a gain or loss.
Involuntary conversions oftentimes occur as the result of events such as a fire, flood or even theft. If such an event is both unusual and occurs infrequently, the gain or loss would be categorized as an extraordinary item and appear as such on the company's income statement.
Example
A specialty vehicle owned by Company A could not be repaired after being caught in a flash flood. Company A purchased the vehicle for $100,000 two years ago. When purchased, the vehicle was thought to have a serviceable life of five years. The annual depreciation on the asset was calculated to be:
= $100,000 / 5, or $20,000 per year
After two years, the accumulated depreciation would be:
= $20,000 x 2, or $40,000
Company A carried insurance on the vehicle and was paid $85,000 as part of the loss settlement. The gain or loss on the disposition of the vehicle would be calculated as:
Cost of Machinery | $100,000 |
Less: Accumulated Depreciation | $40,000 |
Net Book Value | $60,000 |
Proceeds from Insurance Policy | $85,000 |
Gain from Disposition of Vehicle | $25,000 |
The following journal entries are needed to remove the asset from the company's books:
Debit | Credit | |
Cash | $85,000 | |
Accumulated Depreciation | $60,000 | |
Gain on Disposal | $25,000 |
Related Terms
- The financial accounting term property, plant, and equipment is used to describe assets of a long lasting nature, which are used in the normal operation of the company. The most common types of property, plant, and equipment are land, buildings, and machinery.
Moneyzine EditorSeptember 21st, 2023 
The financial accounting term costs subsequent to acquisition refers to additional expenditures associated with property, plant and equipment. In general, companies make four types of investments in existing assets: additions to plant, improvements, reinstallations and repairs.Moneyzine EditorNovember 6th, 2024
The financial accounting term additions to property, plant, and equipment refers to one type of cost subsequent to acquisition. Additions are defined as an increase or expansion of these assets and the cost is typically capitalized.Moneyzine EditorJanuary 4th, 2024
The financial accounting term improvements and replacements refers to a category of cost subsequent to acquisition. A replacement occurs when a similar asset is substituted for the original asset, while an improvement involves the substitution for a more advanced asset.Moneyzine EditorNovember 6th, 2024- The financial accounting term reinstallation and rearrangement refers to a category of cost subsequent to acquisition. A rearrangement or reinstallation occurs when equipment is moved from one location and installed in another. This is typically performed to increase production at the receiving location.Moneyzine EditorSeptember 21st, 2023
- The financial accounting term repairs to property, plant, and equipment refers to a category of cost subsequent to acquisition. Repairs are typically broken down into two subcategories: ordinary and major. Ordinary repairs are typically expensed, while major repairs may be capitalized if certain criteria are met.Moneyzine EditorSeptember 21st, 2023
- The term sale of property, plant, and equipment refers to the selling or exchange of the company's assets. When the sale of property, plant, or equipment occurs, the company must compare the asset's original purchase price and accumulated depreciation to its selling price to determine if there was a gain or loss on the transaction.Moneyzine EditorSeptember 21st, 2023
