What are Proceeds?
Proceeds refers to the cash received from the sale of goods or assets during a particular period. The total is obtained by multiplying the quantities sold by the selling price per unit. The proceeds received before any deductions are made are known as gross proceeds, and they comprise all the expenses incurred in the transaction such as legal fees, shipping costs, and broker commissions.
Net proceeds equal the gross proceeds minus all the costs and expenses that the business incurred when carrying out the transaction. Comparing the net and gross proceeds of a business can help management know how profitable the business is, and understand how much of its profits are lost to expenses.
Gross Proceeds vs. Net Proceeds
When a business sells an asset, whether tangible or intangible, it receives a payment, which is the gross proceeds. The amount includes the costs of production and other costs and expenses related to the transaction.
For example, if a real estate agent sells a house for $100,000, that amount represents the gross proceeds. The amount includes the agent’s fees or commission, as well as the closing costs. The concept of gross proceeds also applies to other types of assets, such as bonds and stocks where broker fees and related transaction costs are incurred.
Net proceeds are the final consideration that the asset owner/seller receives after deducting all costs and expenses incurred in the transaction. When disposing of a house, the first cost that is deducted from the cash received is the success fee. That fee is paid to the real estate agent for the successful sale of the house to another party.
The other costs incurred include closing date obligations such as deferred taxes and outstanding debt on the property. All the costs are deducted before the owner receives the final proceeds from the sale of the house. A higher selling price does not always result in higher net proceeds, since too many transaction costs and hidden expenses may reduce the net proceeds.
Net Proceeds in Real Estate
When selling a home, the seller needs to take into account the sale price amount and all the costs associated with selling the real estate property. The sale price amount is recorded on the credit side because that is what the seller receives. Other credits include prepaid property taxes. The costs associated with selling homes are charged against the sale price, and will, therefore, be recorded on the debit side.
Some of the costs that may be recorded on the debit side include escrow handling fees, transfer fees, outstanding mortgage, excise tax, pest inspection costs, home warranty, roof inspection, repairs, homeowner association fees, etc. Add up all the debits to determine the total debts and deduct the total from the credits to get the seller’s net proceeds.
Net Proceeds in Capital Gains Taxes
The net proceeds from the sale of an asset are recorded in an individual or corporate account. Taxpayers are required to pay taxes to the federal government on the capital gains realized from assets. In order to obtain the capital gains or losses on assets, you must have the basis amount, which is the amount paid to acquire the asset.
Assume that an investor purchased $5,000 in stock and paid an additional $50 in commissions to the broker. The total basis is $5,050. If the stock is inherited, the asset basis becomes the fair market value on the day that the original owner died, regardless of whether it is more or less than what was initially paid.
If the investor sells the stock to another investor for $6,000 and pays $60 in broker commissions, then the net proceeds of the transaction are $5,940 ($6,000 – 60). To get the capital gains, subtract the basis from the net proceeds. It brings the capital gains to $890 ($5,940 – $5,050). The tax rate applied to the capital gains or losses depends on the duration the asset was owned.
How to Record Proceeds and Associated Expenses
An asset sale is recorded in the books of accounts with the goal of eliminating the asset and its accumulated depreciation from the balance sheet. Here are the options for the treatment of an asset sale transaction:
1. Sale of asset journal entry
When a sale transaction takes place, a journal entry is made to update the depreciation expense, increase the cash account with the amount received, decrease (credit) the asset account, and record the gain or loss on the sale of the asset.
2. Depreciation expense
The depreciation on the disposed asset is recorded to update the book value of the asset. The amount is debited in the depreciation expense account and credited in the accumulated depreciation account. It is captured in the income statement as an expense that reduces the gross proceeds. The accumulated depreciation reduces the value of the asset to the current book value.
3. Gain or loss on the sale of an asset
The difference between the current book value of the asset and the proceeds received from the sale of the asset determines if the business made a gain or a loss. If the proceeds exceed the current book value of the asset, then the business is deemed to have made a gain.
Conversely, if the proceeds received are less than the asset book value, the business is deemed to have incurred a loss. The proceeds received are debited in the cash account, while the loss is debited in the loss on sale of asset account and the gain credited in the gain on sale of asset account. The gain raises the gross profit in the income statement, whereas the loss reduces the gross profit in the income statement.
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