Definition and Classification of Capital Losses

Capital Losses: Decrease in value of long-term capital assets such as fixed assets and investments below their original cost, resulting from internal factors like depreciation or external factors like market fluctuations.

Classification:

By Nature: Operating losses from normal depreciation and wear of assets, extraordinary losses from accidents and natural disasters, and impairment losses from deteriorating economic conditions or technical obsolescence.

By Realization: Realized when actual sale of asset below cost and appears in income statement, and unrealized from market value decline without sale and recorded as reserve in equity.

By Type: Fixed asset losses from decline in building and equipment values, financial investment losses from falling stock and bond prices, and foreign currency losses from exchange rate fluctuations.

By Treatment: Recoverable when future conditions improve and can be reversed accounting-wise, and non-recoverable when permanent damage or complete end of asset value.

Accounting Treatment of Capital Losses

Upon value decline: From Impairment Loss to Asset Impairment Provision

Upon sale at loss: From Cash From Accumulated Depreciation From Fixed Asset Sale Loss to Fixed Asset

For financial investments: From Unrealized Investment Loss to Financial Investments

Tax Treatment of Capital Losses

Tax treatment of capital losses in Saudi Arabia:

Realized losses: Losses resulting from actual sale of fixed assets or investments below their book cost, deductible from tax base according to Saudi income tax system. Include real estate, equipment, and financial investment sale losses, requiring documentation with official sale contracts.

Unrealized losses: Fair value decline of assets without actual sale, such as investment price drops or estimated real estate value decline. Not tax-accepted in Saudi Arabia until actual realization, applying the realization principle in tax system.

Offsetting Losses Against Capital Gains

Concept: Deducting capital losses from capital gains in same tax period to reduce tax base.

Application mechanism: Direct offset of asset sale losses against other asset sale gains, calculating net capital gains/losses, and applying tax rate on positive net.

Rules: Priority of offset over deduction from ordinary income, requirement of same business activity type, and complete transaction documentation.

Example: Company sold property with 100,000 SAR profit and equipment with 40,000 SAR loss = net capital gains 60,000 SAR subject to tax.

Surplus: Losses exceeding gains carried forward to next five years.

Closing Capital Loss Account and Practical Examples

At fiscal year end: Transfer capital loss account balance to profit and loss or retained earnings account based on loss nature.

Entry for realized losses: From Profit and Loss to Fixed Asset Sale Loss

Entry for unrealized losses: From Retained Earnings to Investment Impairment Loss

Practical examples:

Example 1: Company sold machine costing 100,000 SAR (accumulated depreciation 30,000) for 50,000 SAR: Loss = 50,000 - (100,000 - 30,000) = 20,000 loss Entry: From Cash 50,000 + From Accumulated Depreciation 30,000 + From Asset Sale Loss 20,000 to Machinery 100,000

Example 2: Investment value declined from 200,000 to 150,000 SAR: Entry: From Investment Impairment Loss 50,000 to Financial Investments 50,000

Closing: From Profit and Loss 70,000 to Asset Sale Loss 20,000 + to Investment Impairment Loss 50,000