Page 454 - Accounting Principles (A Business Perspective)

This book is licensed under a Creative Commons Attribution 3.0 License

Another way to compute the gain of USD 2,000 on the exchange is to use the fair market value of the old asset
less the book value of the old asset. The calculation is as follows:

Machine cost $ 45,000
Accumulated depreciation 38,000
Book value $ 7,000
Fair market value of old asset
(trade-in allowance) 9,000
Gain realized $ 2,000
Remember, when the book value and the market value of the old asset are different, companies always recognize
a gain or a loss on an exchange of nonmonetary assets having commercial substance. As discussed earlier, they do
not recognize a gain or loss on an exchange of nonmonetary assets not having commercial substance.
Exchanges of nonmonetary assets not having commercial substance Often firms exchange plant

assets such as automobiles, trucks, and office equipment by trading the old asset for a similar new one. Once in a
while, such an exchange does not result in an expected change in future cash flows and therefore lacks commercial
substance. When such an exchange occurs, the company receives a trade-in allowance for the old asset, and pays
the balance in cash. Usually, the cash price of the new asset is stated. If not, accountants assume the cash price of
34
the new asset is the fair market value of the old asset plus the cash paid.
When such assets are exchanged, we must modify the general rule that new assets are recorded at the fair
market value of what is given up or received, whichever is clearer. Thus, companies record the new asset at the book

value of the old asset plus the cash paid. When applying this rule to exchanges of assets where no commercial
substance results, firms recognize no losses or gains.
To illustrate the accounting for exchanges of nonmonetary assets that do not have commercial substance,
assume that a delivery service exchanged USD 50,000 cash and truck No. 1—which cost USD 45,000, had USD
38,000 of up-to-date accumulated depreciation, and had a USD 5,000 fair market value—for truck No. 2. The new
truck has a cash price (fair market value) of USD 55,000. The delivery service realized a loss of USD 2,000 on the
exchange which cannot be recorded. The loss is calculated as follows:
The journal entry to record the exchange is:

Cost of trunk No. 1 $ 45,000
Accumulated depreciation 38,000
Book value $ 7,000
Fair market value of old asset
(trade-in allowance) 5,000
Loss indicated (but not recorded) $ 2,000
However, if a loss is indicated and is added to the recorded value of the new asset, the asset may later be written
down because of rules of impairment (as required by FASB Standard No. 144), a topic left to Intermediate
Accounting texts.

34 Trade-in allowance is sometimes expressed as the difference between list price and cash paid, but we choose to
define it as the difference between cash price and cash paid because this latter definition seems to agree with

current practice for exchange transactions.

Accounting Principles: A Business Perspective 455 A Global Text