Exchange of Fixed Assets Commercial Substance and Entries

Subsequent costs incurred in connection with property and equipment are capitalized if the asset has been made bigger or better in some way. If the length of the remaining useful life is extended, capitalization is established by reducing accumulated depreciation. In most cases, fixed assets are acquired through exchange of monetary assets, such as cash. However, there are instances where two companies engage in barter transactions of fixed assets.

This gain shall not be recorded as income and it should not be presented in the income statement. Instead, such gain shall be deducted from the market value of the new assets received. The old machinery was exchanged with a new one on 1st Jan, 2004. The supplier of the new machine has accepted $42,000 for the old machine as trade in allowance. The cost of the old asset is $140,000 and accumulated depreciation till the date of exchange is $96,000. Once again, the book value has increased but, in this situation, the life of the asset has also been lengthened.

Asset Swap – Explained

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.

Remove the assets that are gone (the dump trucks in this case) along with the accumulated depreciation that goes with them, and then record the new asset on the books at fair market value. Assuming that no change in either the useful life or the residual value occurs as a result of this work, depreciation expense will be $75,375 https://accounting-services.net/accruals-definition/ in each of the subsequent twelve years. The newly increased book value is simply allocated over the useful life that remains. The book value of the old asset must be reduced by an amount equal to the allocated fair value of the new asset. Gains and losses are recognized on a portion of the old asset being exchanged.

Accounting For Asset Exchanges

Its presence only slightly modifies the preceding accounting by adding one more account (typically Cash) to the journal entry. Yes, if the exchange is between parent and subsidiary companies then this is not considered to be an asset exchange; both assets are recorded at their full book values in the consolidated Financial Statements. Gain or loss on an exchange transaction is equal to the difference between the fair value for the book value of the old asset. Losses are only recognized on the portion of the asset that is disposed of.

The new equipment to be received has a current market value of $40,000. Generally, the fair value of the items sacrificed equals the fair value of the items received. Most exchanges involve properties of relatively equal worth; a value of $100,000 is surrendered to acquire a value of $100,000. Thus, if known, the fair value given up always serves as the basis for recording the asset received. Only if the value of the property traded away cannot be readily determined is the new asset recorded at its own fair value. When a company exchanges a fixed asset with another and the transaction has commercial substance, it records the asset acquired at its fair value or the fair value of assets given up, whichever is readily available.

Does Fixed Assets(FA) Generate Separate Accounting For Exchange Rate Variance(ERV) Lines?

In such cases, the known value is used with the remainder of the cost assigned to the other property. Assume that the total cost of these properties is $5,030,000. If the land is known to be worth $4.5 million but no reasonable value can be ascribed to the building, the excess $530,000 is arbitrarily allocated to this second asset. Sometimes a new car purchase is accompanied by a “trade in” of an old car. In business, equipment is often exchanged (e.g., an old copy machine for a new one). Exchanges can be motivated by tax rules because neither company may be required to recognize a taxable event on the exchange.

• The exchange does not involve or involves only a small amount of monetary assets (i.e., premiums).
• The asset swap has commercial essence, which is one of the important conditions for the exchange of assets to be measured by fair value and is also an important concept introduced by the asset swap standard.
• Asset swap refers to the exchange of non-monetary assets such as inventory, fixed assets, intangible assets, long-term equity investments and bond investments that are not intended to be held to maturity.
• Gain or loss on an exchange transaction is equal to the difference between the fair value for the book value of the old asset.

The recorded cost of the new asset cannot exceed the fair value of the new asset. Click here to extend your session to continue reading our licensed content, if not, you will be automatically logged off. These materials were downloaded from PwC’s Viewpoint (viewpoint.pwc.com) under license. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content.

Impairment of Fixed Assets

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.

Reported cost is established based on the fair value of the property surrendered because that measures the company’s sacrifice. The asset received is only recorded at its own fair value if the value of the asset given up cannot be determined. When more than one asset is acquired in a transaction, the cost allocation is based on the relative fair values of the items received.

Are there any exceptions to recognizing a gain or loss on an asset exchange?

In accounting for such exchanges of non-monetary assets, we need to find out if the transaction has commercial substance. In plain English, it means whether the exchange would change the cash flows of the business to a significant extent. If the cash flow pattern changes, the transaction is Exchange of Fixed Assets said to have commercial substance and if doesn’t, it has no commercial substance. The asset swap has commercial essence, which is one of the important conditions for the exchange of assets to be measured by fair value and is also an important concept introduced by the asset swap standard.

An exchange has commercial substance if, as a result of the exchange, future cash flows are expected to change significantly. For instance, if a company exchanges a building for land (a dissimilar exchange), the timing and the future cash flows are likely to be different than if the exchange had not occurred. Most property exchanges qualify as having commercial substance. However, if the exchange is not expected to create a significant change in future cash flows, the exchange does not result in commercial substance. However, if the future cash flows are likely to be significantly different, then the exchange of similar assets has commercial substance.

AccountingTools

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 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.