Chapter 1.2® - Exchanging Capital Assets - Exchange of High End Computer for Trailer Equipment Journal Entries, Trade-In Allowance Subtracted from Book Value
Many capital assets such as automobiles, machinery & office equipment are disposed of by exchanging them for new assets. This acquisition of a new asset by exchanging a used asset is called a trade-in. In a typical transaction, a trade-in allowance is received on the old asset and remaining balance is settled in cash. In this scenario from an accounting perspective, both the cost of the capital asset and related accumulated amortization of the old asset must be removed from the books. Any gain or loss resulting from this must be booked in the current period.
For example, consider BB Corporation exchanges a high-end computer for trailer equipment on June 1st, 2009 that has a fair market value of $40,000. The original cost of the high-end computer was $35,000 and related accumulated amortization was $15,000 up to the date of the exchange, resulting in a net book value of ($35,000 - $15,000) = $20,000. BB Corp. received a trade-in allowance of $11,000 for the computer and paid the balance in cash. Here is the resulting journal entry:
The Loss on Exchange is calculated by subtracting the trade-in allowance of $11,000 from the Book value of the Computer of $20,000 ($20,000 - $11,000) = $9000. Since this is a loss of $9,000, we debit this to a “Loss on Exchange” account, and this helps us calculate the final Cash price we have to pay for this high-end computer, $29,000.
If however the trade-in allowance was higher than the book value of the high-end computer, this would result in a gain. To illustrate, consider the same example as above but the firm receives a trade-in allowance of $25,000.
Since we have a trade-in allowance of $25,000 which is greater than the book value of the high-end computer of $20,000, this results in a gain of $5000 ($25,000 - $20,000). This then helps us calculate the final cash price we must pay to settle this exchange, $15,000.