Accounting: The Language of Business (Part 63)

Your own business growth and success depends on many things, and along that growing path, you are going to have to concede certain responsibilities and activities - whether for your accounting, your production, or day-to-day management.

Michael Gerber

Fixed Assets and Intangible Assets (Part G)

by

Charles Lamson

Exchanging Similar Fixed Assets

Old equipment is often traded in for new equipment having a similar use. In such cases, the seller allows the buyer an amount for the old equipment traded in. This amount, called the trade-in allowance, may be either greater or less than the book value of the old equipment. The remaining balance---the amount owed---is either paid in cash or recorded as a liability. It is normally called boot, which is its tax name.

Gains on Exchanges

Gains on exchanges of similar fixed assets are not recognized for financial reporting purposes. This is based on the theory that revenue occurs from the production and sale of goods produced by fixed assets and not from the exchange of fixed assets. 

When the trade-in allowance exceeds the book value of an open asset traded in and no gain is recognized, the cost recorded for the new asset can be determined in either of two ways:

1. Cost of new asset = List price of new asset - Unrecognized gain

or

2. Cost of new asset = Cash given (or liability assumed) + Book value of old asset 

To illustrate, assume the following exchange: 

Recorded cost of new equipment:

The entry to record this exchange and the payment of cash is as follows:

Not recognizing the $300 gain ($1,100 trade-in allowance - $800 book value) at the time of the exchange reduces future depreciation expense. That is, the depreciation expense for the new asset is based on a cost of $4,700 rather than on the list price of $5,000. In effect, the unrecognized gain of $300 reduces the total amount of depreciation taken during the life of the equipment by $300.

Losses on Exchanges

For financial reporting purposes, losses are recognized on exchanges of similar fixed assets if the trade-in allowance is less than the book value of the old equipment. When there is a loss, the cost recorded for the new asset should be the market (list) price. To illustrate, assume the following exchange: 

The entry to record the exchange is as follows: 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 406-408*

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