How to Exchange Assets When Valuing PP&E
Accounting for transactions that involve exchanging one tangible asset for another arises a lot when trading in an old business vehicle for a new one — an occurrence you’ve probably encountered in your personal life. Key to these types of transactions is the fair value, which is what the asset would fetch in an open marketplace, in other words — a transaction between unpressured parties.
Commercial substance comes into play if the asset exchange affects future cash flows.
For example, if a business trades in an old delivery truck for a new one, the new delivery truck most likely has a longer useful life. This extended useful life affects future cash flows. GAAP is picky about accounting for these types of transactions, so make sure you follow these guidelines:
Commercial substance exists: Recognize gains or (loss) on the exchange contemporaneously.
No commercial substance, no cash changing hands: Defer gains and recognize losses contemporaneously.
No commercial substance and cash received: Recognize gain and loss contemporaneously.
If the cash received in an exchange that lacks commercial substance is less than 25 percent of the fair value of the exchange, only a partial gain is recognized.
GAAP and International Financial Reporting Standards (IFRS) are similar in their treatment of exchanges of nonmonetary assets.
Make sense? Well, maybe not. Time for a typical homework assignment involving an asset exchange with a gain on exchange and commercial substance. Here are the facts surrounding this transaction:
ABC Manufacturing trades in two old delivery vans and coughs up $15,000 cash for a large delivery truck.
The fair value of the two old delivery trucks is $55,000. Their book value is $42,000 (cost of $75,000 minus accumulated depreciation of $33,000).
The fair value of the two old delivery trucks is more clearly evident than the fair value of the larger delivery truck that is the subject of the exchange.
The following figure shows how to figure gain for this transaction.
Following is the lowdown on the journal entries. The $70,000 value for the delivery truck comes from adding the delivery vans’ fair value of $55,000 plus the $15,000 cash.
Trading in one similar asset for another is typically considered a like-kind exchange and new depreciable basis is reduced by the unrecognized gain on disposal.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
