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.