Question

Use the following information to answer the next 3 questions:

1-Desert, Co. is trading a machine which has an original cost of $60,000 and accumulated depreciation of $35,000, for another fixed asset. For each of the following independent scenarios, determine the amount to be capitalized for the new fixed asset that Desert is acquiring (i.e. the original cost Desert will report on their balance sheet for the new asset) and the gain or loss to be recognized at the time of the exchange.

Scenario 1:

Desert received in this exchange a machine with a fair value of $18,000 and also received $10,000 cash. The exchange lacks commercial substance.

What is the Original Cost of the NEW Asset reported on Desert's Balance Sheet?

What is the amount of the gain or loss (if any) Desert will recognize as a result of this transaction?

Answer 1

Commercial substance means that there will be change in the future cash flow with this transaction. Exchanges having commercial substance should be recorded at fair value whereas the transaction that lacks commercial substance the transaction should be recorded at book value. If there is additional cash is received along with the exchanged assets then proportionate gain will be recognised Proportionate gain/loss = Cash Received/( Fair value of new asset + Cash received) x Book Value of Old Asset Step 1 Particulars Amount Cost of the Asset given in exchange Less: Accumulated Depreciation Book Value of the asset $60,000 $25,000 Step 2Calculation of gain $28,000 $8,929 Fair Value of new Asset Proportionate Gain [($10000/$28000) x $25000] Journal Entry Particulars New Assets Cash Accumulated Depreciation Old Asset Gain on disposal of Old Asset (To record entry for exchange of assets) Debit Credit $23,929 $10,000 $35,000 $60,000 $8,929 The Original Cost of the NEW Asset reported on Desert's Balance Sheet$23,929 The amount of the gain recognized as a result of this transaction $8,929