The following examples illustrate exchange transactions for scenarios involving both losses and gains. The accounting for exchange of fixed assets which similar in nature depends on whether the net book value of assets to be given up is more or less than the current market value of the assets to be received. When the net book value of assets given up is higher than the market value of assets to be received, it is considered a loss on exchange. This loss is recorded as an expense and presented in the income statement as a non-operating expense.
Exchanges that have commercial substance (future cash flows are expected to change) should be accounted for at fair value. For example, two companies may swap inventory and neither expects a significant change in cash flows because of the trade. Gains are not recorded on exchanges lacking commercial substance and are typically illustrated in more advanced courses. The accounting for the exchange of fixed assets shall be carried out properly depends on whether there is gain or loss on the exchange of fixed assets. If there is a loss on the exchange, the new assets shall be recorded at their market value.
Example 1: Exchange involving Commercial Substance
The $150,000 might extend the building’s life without creating any other improvement. Because the building will now generate revenue for a longer period of time than previously expected, this cost is capitalized. The asset is not physically bigger or improved but its estimated life has been extended. Consequently, the building https://accounting-services.net/how-to-become-a-cfo-in-7-steps/ is not increased directly, but instead, accumulated depreciation is reduced. In effect, this expenditure has recaptured some of the previously expensed utility. In contrast, if the net book value of the assets given up is lower than the current market value of the assets to be received, it is considered as a gain on exchange.
This reporting is not appropriate because nothing has changed for either party. In reality, no gain occurred since the companies retain the same financial position as before the trade. Thus, in creating its official guidance as described above, FASB held that an exchange must have commercial substance to justify using fair value. In simple terms, the asset acquired has to be different from the asset surrendered as demonstrated by the amount and timing of future cash flows. Without a difference, no rationale exists for making the exchange. If a trade does not have commercial substance, net book value is retained so that no gain is recognized.
Gain or Loss on Exchange
In contrast, if more of the cost is allocated to the building, depreciation expense is higher and taxable income and income tax payments are reduced. Occasionally, in a basket purchase, the value can be determined for one of the assets but not for both. As an example, the above land might be worth $4.5 million but no legitimate value is available for the building. Similar structures might not exist in this area for comparison purposes.
In the ordinary course of business, it is quite common that an entity exhange the old asset with the new asset in order to fully utilize its production capacity. Any difference between the value of old asset and new asset is settled by the payment or receiving of cash. Company A gives an old truck ($1,000,000 cost, $750,000 accumulated depreciation) and $50,000 cash for a boat. A summary of the process used to account for asset exchange is given below.
Exchange of Fixed Assets
A $15,000 gain is recognized on the exchange ($100,000 fair value less $85,000 book value). The gain results because the old limousine had not lost as much value as the depreciation process had expensed. The net book value was reduced to $30,000 but the vehicle was actually worth $45,0001. The fair value approach for exchanges having commercial Exchange of Fixed Assets substance will ordinarily result in recognition of a gain or loss because the fair value will typically differ from the recorded book value of a swapped asset. There is deemed to be a culmination of the earnings process when assets are exchanged. In other words, one productive component is liquidated and another is put in its place.
- Reported cost is established based on the fair value of the property surrendered because that measures the company’s sacrifice.
- The following examples illustrate exchange transactions for scenarios involving both losses and gains.
- In the previous article, we have covered the journal entry for disposal of fixed assets which mainly focuses on the discard and sales of fixed assets.
- The accounting for exchange of fixed assets which similar in nature depends on whether the net book value of assets to be given up is more or less than the current market value of the assets to be received.
- Similar structures might not exist in this area for comparison purposes.
- Exchanges that have commercial substance (future cash flows are expected to change) should be accounted for at fair value.
At the end of second year, Gomal exchanges 200 dumper trucks for 100 concrete mixers. The total fair value of dumper trucks is $20 million, and the fair value of concrete mixers is $22 million but the fair value of dumper trucks is more reliable because an active market exists for them. If the dumper truck’s fleet costed $30 million and the concrete mixers costed $35 million and useful life of each item is 10 years, find out how both companies should account for the transaction.