Trade-In of Assets

Trade-In of Assets Special rules apply to accounting for the trade-in of assets. In applying these rules, it is important to understand that it makes a difference whether the assets being exchanged are alike or of the same basic type, or whether they are fundamentally different. An example of an exchange of similar assets is an exchange of one truck for another truck. An example of an exchange of dissimilar assets is an exchange of a truck for a printing press. The relative age and condition of the assets make no difference in the determination of whether or not they are similar. For example, a very common exchange of similar assets involves trading in old automobiles on new automobiles. Most exchanges of noncash assets typically involve assets of a similar type. The principal rule that governs accounting for the exchanges of similar assets is that gains on these exchanges are generally not rec-ognized; however, losses on the exchanges of similar assets are recog-nized. Unrecognized gains are subtracted from the recorded cost of the newly acquired asset. This rule applies only to exchanges of similar assets. In accounting for exchanges of dissimilar assets (assets that are fundamentally different), both gains and losses are recognized. To illustrate accounting for asset exchanges, assume first that the Paul Company equipment described above is traded in to an equipment dealer on a similar item of equipment on January 1, 1995. For conve-nience, we will refer to the equipment traded in as the "old" equipment and to the equipment acquired as the "new" equipment. The old equipment originally cost $5,000, and the balance in the related accumulated depreciation account is $1,800, resulting in a book value of $3,200. Similar Assets Exchanged with a Gain In the first situation assume that the official list price and the fair market value of the new equipment are the same—$5,500 and that as a part of the transaction, Paul Company will pay the dealer $2,000 in cash. These facts are summarized in Exhibit. To record the transaction Paul first must analyze it in terms of what is being given up and what is being received. An analysis of the items given up indicates that the relevant values are book values. The book value of the asset given up (c) must be removed from the books by debiting accumulated depreciation (b) and crediting the asset (a). An analysis of the items received indicates that the relevant values are fair market values. If the list price and the fair market value of the new asset are different, as is frequently the case for many assets such as automobiles and trucks that are sold below their sticker prices, the cost or fair market value is used to record the transaction. In this example the list price and the fair market value of the new asset are the same. In analyzing this transaction, notice that Paul Company is giving up two things: an old asset with a book value of $3,200 and $2,000 in cash. Therefore, the total book value of the items given up is $5,200 (c + d). Paul is receiving one item, the new asset, which is worth $5,500 (e). In this situation the facts indicate a gain-Paul is receiving more ($5,500) than is being given up ($5,200). This is where the rule governing exchanges comes into play. The facts indicate a gain of $300, but the accounting rules state that a gain should not be recognized on the exchange of similar assets. Consequently, the value of the new asset is recorded at the book value of what was given up to acquire it-$5,200 (c + d) in this case. The general journal entry to record this exchange is: The amounts recorded in three of the four accounts involved in the entry are fairly easy to determine. The old equipment is being disposed of and must be removed from the books. With the old equipment goes its related accumulated depreciation account of $1,800. The payment of $2,000 of cash is also obvious. The item requiring some thought is the valuation of the new asset. Its fair market value is $5,500, but if the new asset were recorded on the books by a debit of $5,500, the above journal entry would no longer balance. That is, the total debits would be $7,300 and total credits would only be $7,000. One way to make the entry balance would be to credit an account such as Gain on Exchange of Assets for $300, which is what would be done if the assets were fundamentally different. However, since the exchanged assets are sim-ilar, the accounting rules provide that no gain should be recognized. Therefore, the value of the new asset is based on what was given up in order to acquire it. What was given up was an old asset with a book value of $3,200 and $2,000 of cash—a total of $5,200, which becomes the recorded cost of the new asset.