Recoverable amount is the higher of an asset’s fair value less costs to sell and its value in use. Companies can exchange similar assets or dissimilar ones . Recognizing the gain or loss on the exchange will depend on the types of assets involved. It looks complicated, but the idea is simple. Remove the assets that are gone along with the accumulated depreciation that goes with them, and then record the new asset on the books at fair market value. When a plant asset is exchanged for a similar plant, loss is recognised but the gain is not. Gain is not considered because the earnings lives of the asset surrendered are not considered to be complete.

• Any gain or loss is determined by comparing the fair value assigned to the new asset with the total of the used asset’s book value plus any cash payment.
• In the case of a limited life, the cost of a franchise should be amortized as an operating expense over its useful life.
• It is the leftover fixed asset value after deducting the accumulated depreciation from its original cost.
• The nominal cost of taking title to it.
• Without a difference, no rationale exists for making the exchange.
• To use this method, the total units of activity for the entire useful life are estimated and that amount is divided into the depreciable cost to determine the depreciation cost per unit.

The, Accounting Principles Board has decided that a company should record as assets the costs of Intangible assets acquired from others. However, the company should record as expenses the cost of developing intangible assets. 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. To account for such exchanges of nonmonetary assets, we need to find out if the transaction has commercial substance. In plain English, we need to find out whether the exchange would change the cash flows of the business to a significant extent.

Definition of plant assets

To use this method, the total units of activity for the entire useful life are estimated and that amount is divided into the depreciable cost to determine the depreciation cost per unit. The declining-balance method produces a decreasing annual depreciation expense over the useful life of the asset. Intangibles do not usually use a contra asset account like the contra asset account Accumulated Depreciation used for plant assets. Whether a plant asset is sold, exchanged, or retired, the company must determine the book value of the plant asset at the time of disposal. During the useful life of a plant asset, a company may incur costs for ordinary repairs, additions, and improvements. Under the straight-line method, an equal amount of depreciation expense is recorded each year of the asset’s useful life.

Gain on sale is $3,000 ($8,000 sales price minus $5,000 book). The account can include machinery, https://simple-accounting.org/ equipment, vehicles, buildings, land, office equipment, and furnishings, among other things.

We comment on the IASB’s proposed amendments to IAS 16

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,” the company records the asset acquired at its fair value . In this case the new asset is recorded at an amount equal to the sum of the book value of the asset traded in plus any cash paid. So acquiring a new similar asset does not result in an immediate gain to the business enterprise. In fact, this trade-in is merely an extension of the life and usefulness of the original machine. A plant asset may be exchanged for a similar asset, for example, an old machine traded in for a newer model or dissimilar assets, for example a machine being traded in for a truck.

The company reports the thief to its insurance provider, which, after subtracting the deductible, cuts the company a check for $4,000. The following figure shows the journal entry to record this transaction.

IASB publishes proposed IFRS Taxonomy update

Extending an asset’s estimated life reduces depreciation and increases net income for the period. The rational for this treatment is that continual restatement of prior periods would adversely affect the users’ confidence in financial statements. The units-of-activity method is suited to factory machinery and such items as delivery equipment and airplanes. Under the units-of-activity method, the life of an asset is expressed in terms of the total units of production or the use expected from the asset. Cost—Plant assets are recorded at cost, in accordance with the cost principle. The cash equivalent price is equal to the fair market value of the asset given up or the fair market value of the asset received, whichever is more clearly determinable.

• Thus, when a change is made there is no correction of previously recorded depreciation expense, and depreciation expense for current and future years is revised.
• A decline in revenue-producing ability may also occur because of obsolescence—the process by which an asset becomes out of date before it physically wears out.
• Straight-line depreciation is the most widely used method of depreciation.
• It is not an exhaustive list, and the company can further categorize its assets depending on its requirements and accounting policies.
• Exchange of assets with a difference in future cash flows.
• When such assets are exchanged, we must modify the general rule that new assets are recorded at the fair market value of what is given up or received, whichever is clearer.

Once cost is established, it becomes the basis of accounting for the plant asset over its useful life. Describe methods for evaluating the use of plant assets. The next section discusses natural resources. Note the underlying accounting principle of matching the expenses with the revenues earned in that same accounting period.

Calculation of Cost of Plant Assets

This ratio is computed by dividing net sales by average total assets. If disposal occurs at any time during the year, the depreciation for the fraction of the year to the date of disposal must be recorded. The practice of timing the recognition of gains Accounting For Exchange Of Plant Assets and losses to achieve certain income results is known as earnings management. Additions and improvements are capital expenditures. Ordinary repairs – expenditures to maintain the operating efficiency and expected productive life of the asset.

Once again, the book value has increased but, in this situation, the life of the asset has also been lengthened. This recognition principle is applied to all property, plant, and equipment costs at the time they are incurred. These costs include costs incurred initially to acquire or construct an item of property, plant and equipment and costs incurred subsequently to add to, replace part of, or service it. IAS 16 Property, Plant and Equipment outlines the accounting treatment for most types of property, plant and equipment. When exchanging nonmonetary assets, there is oftentimes the payment of boot as part of the transaction. Boot is a monetary consideration for the difference between the fair market value of the assets exchanged. When boot is received, a partial gain on the transaction should be booked.

IAS 16 — Property, Plant and Equipment

To record the exchange of non-monetary assets with no commercial substance . Note that the patent account is reduced directly by the amount of the amortization expense. This is in contrast to other long-term asset accounts in which depreciation or depletion is accumulated in a separate contra account.

The gain or loss from an involuntary conversion should not be recognized when the enterprise reinvests in replacement assets. All of these answers are correct. Recording depreciation each period is an application of the expense recognition principle. The Accumulated Depreciation account represents a cash fund available to replace plant assets. The discarding of the plant assets usually involves the disposing of the asset for no cash. In this case, if the asset is fully depreciated and leaves no residual value, then the companies simply try to remove the assets using the related contra asset accounts.

There is no cash received for these assets. Companies frequently dispose of plant assets by selling them. By comparing an asset’s book value with its selling price , the company may show either a gain or loss. If the sales price is greater than the asset’s book value, the company shows a gain. If the sales price is less than the asset’s book value, the company shows a loss.

The cost assigned to each should be based on their relative values. Compute the allocation of cost between assets when more than one is required in a single transaction.

Determine gain or loss on exchange of plant assets

As an example, the above land might be worth $4.5 million but no legitimate value is available for the building. Similar structures might not exist in this area for comparison purposes. 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.

• The computation of annual depreciation expense is based on estimates.
• The balances of the major classes of plant assets and accumulated depreciation by major classes should be disclosed in the balance sheet or notes.
• Suppose that, instead of selling the equipment, a thief breaks into the business during the night and steals it.
• For example, the legal life of a patent is 20 years.
• Depreciation should be charged to profit or loss, unless it is included in the carrying amount of another asset [IAS 16.48].

There are uncertainties in identifying the extent and timing of the future benefit of these expenditures. In the saleof an asset, the book value of the asset is compared with the proceeds from the sale. Ordinary repairs are debited to Repair Expense and are immediately charged against revenues. The disclosure is found in the notes that accompany the statements. This method is often referred to as the double-declining-balance method.