Accounting, Analysis, and Principles Durler Company purchased equipment on Janua

Question

Accounting, Analysis, and Principles Durler Company purchased equipment on January 2, 2013, for $112,000. The equipment had an estimated useful life of 5 years with an estimated salvage value of $12,000. Durler uses straight-line depreciation on all assets. On January 2, 2017, Durler exchanged this equipment plus $12,000 in cash for newer equipment. The old equipment has a fair value of $50,000. Accounting Prepare the journal entry to record the exchange on the books of Durler Company. Assume that the exchange has commercial substance. Analysis How will this exchange affect comparisons of the return on asset ratio for Durler in the year of the exchange compared to prior years? Principles How does the concept of commercial substance affect the accounting and analysis of this exchange?

Explanation / Answer

Accounting :

Analysis:

Return on Assets Ratio = Net Income / Average Total Assets

As the book value of the asset increases due to the exchange from $ 32,000 to $ 94,000 during 2017, the denominator value will increase. What change the exchange is going to have on the numerator depends on the useful life on the new asset, its salvage value, and the method of depreciation employed. If we were to assume that the numerator remains the same as last year, return on assets ratio will decline immediately, but is expected to improve with time, as the increased cash flows ( commercial substance) would lead to stronger numerators with times to come.

Principles

Concept of commercial substance implies that the exchange is expected to bring about changes in future cash flows. Exchanges that have commercial substance should be recorded at fair value, and as such, gains are also recognized immediately.

Also, since future cash flows are expected to increase for the entity acquiring the new asset, the return on asset ratio is expected to improve.

Date Account Titles Debit Credit $ $ January 2, 2017 Equipment ( New) 94,000 Accumulated Depreciation ( Old) 80,000 Equipment ( Old) 112,000 Cash 12,000 Gain on Exchange of Equipment 50,000

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