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It is a common practice to exchange a used PPE asset for a new one. This is known as a trade-in. The value of the trade-in agreed by the purchaser and seller is called the trade-in allowance. This amount is applied to the purchase price of the new asset, and the purchaser pays the difference. For instance, if the cost of a new asset is $10,000 and a trade-in allowance of $6,000 is given for the old asset, the purchaser will pay $4,000 ($10,000 – 6,000). |
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Sometimes as an inducement to the purchaser, the trade-in allowance is higher than the fair value of the used asset on the open market. Regardless, the cost of the new asset must be recorded at its fair value, calculated as follows: |
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Cost of new asset = Cash paid + Fair value of asset traded |
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If there is a difference between the fair value of the old asset and its carrying value, a gain or loss results. For example, assume again that equipment was purchased for $20,000 on January 1, 2015. At that time, it had a residual value of $2,000 and a useful life of five years. It is traded on November 30, 2019 for new equipment with a list price of $25,000. A trade-in allowance of $2,500 is given on the old equipment, so cash paid is $22,500 ($25,000 – 2,500). At the time, the old asset has a fair value of only $1,800. In this case, the cost of the new asset is calculated as follows: |
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Cost of new asset = Cash paid + Fair value of asset traded = $22,500 + 1,800 = $24,300 |
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There will be a loss on disposal of $200 on the old equipment, calculated as follows: |
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The journal entry on November 30, 2019 to record the purchase of the new equipment and trade-in of the old equipment is: |
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By this entry, the cost of the new equipment ($24,300) is entered into the accounts, the accumulated depreciation and cost of the old equipment is removed from the accounts, and the amount of cash paid is recorded. The debit difference of $3,800 represents the loss on disposal of the old equipment. |
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