When a company disposes of a fixed asset, sometimes they don't just sell it. Sometimes they trade it in or exchange it for a new fixed asset. Let's check it out. So we're going to talk about exchanging for similar fixed assets, okay? And this is when we're going to trade something in. Trade in, let's say, generally how these examples go is you're trading in, let's say, an old truck for a new truck, right? And that old truck is going to have some value, maybe the dealership is going to give you some trade-in value for giving them the old truck. Well, that's what we're going to deal with here. Okay? So the trade-in value when we give up the old equipment, well, that could be more or less than the net book value, right? We're going to have some net book value that's sitting on our balance sheet for that old truck, right? It's going to have some value on our balance sheet. When we trade it in to the dealership, they don't know what we have sitting on our balance sheet. They could give us more than that, less than that. Any difference between what we actually receive in trade-in value and what's in our net book value, that's going to be a gain or loss on the exchange. Dealership. Okay? Any other cash paid, well, what we from the dealership. Okay? Any other cash paid, what we call this boot, okay? This is the name that it gets in these examples and that comes from taxes. In the taxes, when we talk about some cash exchange, it's usually called boot. Okay? So they talk about one more interesting little term here and it's called commercial substance. So transactions are said to have commercial substance when they're going to change future cash flows. Okay? When future cash flows change as a result of the exchange, well then that transaction has commercial substance. And think about it, our future cash flow is going to change when we have an old truck and we trade it in for a new truck. Yeah, they're quite different, right? You're not trading an old truck for another old truck. Generally, in these questions, what we're talking about is an old truck for a new truck. So the future cash flows are going to change and we say we have commercial substance. And in this class, we're only going to deal with commercial substance. Okay? We're not going to have transactions with no commercial substance. That's left for higher-level courses. Okay? So here we have the steps for dealing with an exchange and it's pretty simple. So we'll go through an example as well.
The first step is to gather information regarding the new equipment. And that's going to be the price of the new equipment minus any trade-in discount that we're going to get from the old equipment, right? So we're going to get some discount for trading something in and that's going to get us the cash we actually pay, right? So we're going to have the price that they ask for minus any trade-in discount and we're actually going to pay the difference, the cash. Right? And this cash, like I said, that is the boot. That's when we talk about boot there. So the second one is to gather information about the old equipment and that's about net book value. We have to remember what we paid for it, the cost of the old equipment, minus accumulated depreciation, gets us our net book value. And we should be experts at that by now, right? We've been dealing with net book value a lot. And then the third step, well, now that we've gathered all our information, we're ready to make our journal entry. First thing we want to do, we're getting rid of old equipment, right? We're getting rid of the old truck and we're getting a new truck. So we've got to remove the old equipment from the books. So the old equipment is going to get off our books with a credit, right? Because it's sitting as an asset with a debit balance. Well, we get it off with a credit and the accumulated depreciation, well that's a contra asset with a credit balance, so we get rid of that with a debit. Okay? So those balances, we've got to clear out whatever balance is on our books related to the old equipment. And then we're going to get new equipment. Right? We have this new asset for the new truck that we're going to be getting. And we're going to add that new equipment to our books with a debit, right? That has to be a debit because it's an asset that we got. We're going to remove any cash that we paid or maybe we created a liability, right? Maybe we didn't pay in cash now, we might have notes payable instead of cash. Either way, that's going to be a credit, right? Because if we pay with cash, well the cash going away is a credit or if we make a liability, well that would be a credit as well. And then we have to balance our equation. Any difference between these numbers is going to be a plug. So we're going to see, do we need more debits? If we need more debits, then it's a loss. Do we need more credits? If we need more credits, then it's a gain, right? Credits are gains. Debits are losses. So we're going to plug in that last number to complete our entry. So let's check out an example here. These are pretty easy. Let's see how this goes. On June 30th, the Exchange Corporation exchanged an old truck for a new truck. The old truck was purchased for $12,000 and had accumulated depreciation of $8,000. The new truck had a list price of $16,000 but the dealership offered $4,600 as a trade-in allowance on the old truck. The transaction has commercial substance, so they always love to throw that in there just to make sure you know that we're going to follow these rules. Journalize this transaction. Okay? Commercial substance. An old truck for a new truck. So let's leave those rules on the screen and let's go through it. So the first thing, let's gather information about the new truck. So the new truck, well, we had the price. They told us the price had a $16,000 price. And this we'll put new over here. So the new had a $16,000 price minus the trade-in value of $4,600, and that's the trade-in. And that's going to equal the cash that we're going to pay. We're going to pay the difference, right? So $16,000 minus $4,600, that's going to come out to $11,400, right? And that's the actual cash that we're going to pay. They didn't say anything about notes payable here. So we're just going to assume we paid the difference in cash. Alright. So now let's do the information about the old. Right? We got the new, now let's do the old. We're on to step 2 up there. Okay? Step 2, gather information about the old. Well, this is finding the net book value, right? The cost minus the accumulated depreciation. So the cost of the old truck, it was purchased for $12,000, right? So this is the cost and remember, that's going to be the value on our balance sheet, right? We're going to have an asset for $12,000 and we're going to have a contra asset for the accumulated depreciation of $8,000 and I'll put that here, accumulated depreciation. So it's going to have a net book value of $4,000, right? The cost minus accumulated depreciation equals our net book value of $4,000. All right, so now we've gotten all our information all in one place. Let's go ahead and make our journal entry. Let's start with removing the old equipment, right? So the old equipment, there was going to be some balance on our balance sheet as an asset for $12,000. So that's going to be a credit here. We're going to credit equipment. And remember, we don't have to do it all in order especially with a journal entry like this. Well, we're going to be making a plug. So we want to get all that we know onto the paper first. So this is a credit for equipment. Actually, I'm going to do it in a different color so we can see it separately. So credit for equipment and that's going to be in the cost, right? The historical cost of $12,000. That's going to be our credit. And we've got to get rid of the accumulated depreciation related to that with a debit, right? It was sitting with a credit balance. So let's get rid of that accumulated depreciation with a debit for $8,000, right? And here I'm going to put equipment old. So you know we were talking about the old and this was related to the old as well. The old accumulated depreciation. And now we got a new truck, right? So we've got to add the new truck to our books. So we're going to debit equipment as well. Right? And this is for the new truck. So I'll put new here. And this is a debit because it's a new asset while we have to debit it here. So what was the price of the truck? Right? The price of the truck is the $16,000. So that's the value of the truck. And then last, we have to do, the cash, right? We paid some cash, so we definitely have to get that off of our books. So we're going to debit our excuse me, credit cash, right? There has to be a credit to cash for the amount that we paid in cash, $11,400, alright? So we're not done yet, right? This doesn't balance out. Our debits equal $8,000 plus $16,000. So our debits are totaling $24,000. Our credits are equal to $11,400 plus $12,000 and that comes out to $23,400. So which one's bigger? Our debits or our credits? Our debits, right? We need more credits to finish up this entry. Let me get out of the way. We need more credits to finish this up, right? Our credits need another $600 more. Right? $24,000 minus $23,400. Well, that comes out to $600. Right? We need $600 more credits to balance this out. So what does that mean? Do we need to take a gain or a loss in this situation? It's going to be a gain, right? Whenever we have more credits, well we need a gain, right? To fill this out with another credit. So we're going to have a gain on exchange here. Got a little cramped because we've got a lot going on, but it's another credit and that's going to be for $600, right? So we had a gain of $600. And this should make sense, right? Because look, we had a net book value on the books. We had this net book value of $4,000. But the trade-in, they gave us a value of $4,600. What's the difference there? $600, right? And that's the gain that we got on this exchange because we only had a net book value of $4,000, but they offered us an extra $600 when we turned when we exchanged it. Cool? So there we go. Let's go ahead and finish this up. Our assets down here, how does this balance out? Well, we had our equipment, it went up by $16,000, but it also went down by $12,000, right? The old equipment coming out of our books. The accumulated depreciation, it went down. So when you see a debit here, this is a debit into our asset category, that's going to be an increase to our assets. Even though it's a decrease to our contra asset, to our asset total, that's an increase of $8,000, okay? And cash, we also paid cash. So I'm going to do that under here. Cash had a decrease of $11,400 so that was a decrease there. So what was our net increase in assets? So $16 was an increase plus another $8, minus $12, minus $11.4. Our net increase was $0.6, which is the $600, right? That's the $600. I did everything in thousands there. So that's $600 there. And over on the equity side, the only thing left in our entry is that gain. So this was a net increase of $0.6 and we had a gain of $0.6 as well, right? And that's $600. Cool? Alright. So everything balances out there. We had a gain of, our equity went up by $600 and our assets went up by $600 because of that gain. Cool? Alright. So now that you see how to do an exchange, why don't you guys try a practice problem. Let's do it now.
