What is a Balancing Charge?

A balancing charge happens when a company sells something it owns for more money than what the company says it’s worth in the books. This thing the company sells is called an asset. An asset is anything a company owns that has value, like equipment, vehicles, buildings, or land.

Why Balancing Charges Happen

The reason a balancing charge occurs is because of something accountants do called depreciation. Depreciation is when a company slowly reduces the value of an asset in its financial records over time as the asset gets older and wears out. Each year, the company records an expense that lowers the asset’s book value. The book value is the original cost of the asset minus all the depreciation expenses recorded so far.

An Example of a Balancing Charge

Let’s say a business buys a machine for $10,000. Each year for 5 years, it records $1,500 in depreciation expense on the machine. After 5 years, the machine’s value in the books is now just $2,500 ($10,000 original cost – $7,500 total depreciation). But then the company sells the machine for $4,000. That $4,000 is more than the $2,500 book value. The $1,500 difference between the $4,000 selling price and the $2,500 book value is the balancing charge.

Why Balancing Charges Matter

Balancing charges are important because they impact a company’s taxable income. Usually, when an asset is sold, the difference between the selling price and book value is recorded as a gain or loss. This gain or loss is included in the company’s taxable income. However, when there is a balancing charge, the rules are a bit different.

Balancing Charges Increase Taxable Income

With a balancing charge, the amount of the charge is added to the company’s taxable income in the year the asset is sold. The company does not record a gain on the sale. Instead, the balancing charge effectively reverses some of the depreciation expense the company claimed in prior years.

Remember, depreciation expense reduces a company’s taxable income. Each year a company claims depreciation, it pays less in taxes. But if the company later sells that depreciated asset for more than its book value, the tax authorities say “hold on, looks like you claimed too much depreciation in the past”. The balancing charge is a way to add that “extra” depreciation back into taxable income.

Balancing Charges Can Create a Tax Liability

Balancing charges often create a tax liability for a company in the year the asset is sold, even if the company did not actually receive any cash profit on the sale. The balancing charge is treated like taxable income, even though it is not actual income received by the business.

How to Calculate a Balancing Charge

Calculating a balancing charge is straightforward. Just take the selling price of the asset and subtract its book value at the time of sale. If the selling price is higher, the difference is the balancing charge. If the book value is higher, there is no balancing charge (the company just records a loss on the sale instead).

Formula for Balancing Charge

Balancing Charge = Selling Price of Asset – Book Value of Asset

Where:

Selling Price of Asset is the actual amount the asset is sold for
Book Value of Asset is the original cost minus the total depreciation recorded so far

Balancing Charge Calculation Example

Let’s go back to our earlier example of the machine purchased for $10,000. The company recorded $1,500 in depreciation each year for 5 years, so the book value was $2,500. Then they sold it for $4,000.

Using our formula:

Selling Price of Asset = $4,000
Book Value of Asset = $2,500
Balancing Charge = $4,000 – $2,500 = $1,500

The $1,500 balancing charge would be added to the company’s taxable income in the year the machine was sold.

Reporting Balancing Charges

When a company has a balancing charge, it must report it on its tax filings. The specific way to report it can vary based on the tax laws in the company’s country. However, the general principle is the same: the balancing charge amount gets added to taxable income.

Balancing Charges on Tax Returns

In many countries, companies file an annual tax return to report their income and calculate the tax they owe. Balancing charges are usually reported on this return in the section where the company lists its income. The company will include the balancing charge amount as a type of taxable income.

The exact line or box on the tax return for balancing charges can vary. Many tax returns have a specific line for “gains on sale of assets” or something similar. The balancing charge is often included here.

Keep Good Records of Asset Sales

Companies must keep careful records of their asset sales to accurately report any balancing charges. This includes:

The original purchase price and date of the asset
All depreciation expenses claimed on the asset over the years
The selling price and date of the asset

Having this information readily available makes it much easier to calculate balancing charges and report them correctly on tax filings.