Question

On January 1, 2010, the Felix Company purchased a machine to use in the manufacture of its product. The invoice cost of the machine was $260,000. At the time of acquisition, the machine had an original estimated useful life of 10 years and an estimated salvage value of $20,000. Annual depreciation was recorded at $24,000 per year. The machine was depreciated using the straight-line method.

On August 1, 2015, Felix exchanged the old machine for a newer model. The new machine had a fair market value of $200,000. The estimated fair value of the old machine was $150,000. Felix also paid $50,000 as part of the exchange transaction.

The old machine was depreciated on Felix’s books up through December 31, 2014.

Required

1. Bring Felix’s depreciation on this machine up to date through the date of the exchange.

2. Prepare the journal entry on August 1, 2015 to record the exchange assuming that

1. the exchange transaction had commercial substance.

2. the exchange transaction lacked commercial substance.

Answer 1

a.

Date	General Journal	Debit	Credit
August 1, 2015	Depreciation expense ($24000 x 7/12)	14000
	Accumulated depreciation-old machine		14000
	(To record depreciation up to date of exchange)

b.

Date	General Journal	Debit	Credit
The exchange transaction had commercial substance
August 1, 2015	Machine (new) [$150000 + $50000]	200000
	Accumulated depreciation-old machine [($24000 x 5) + $14000]	134000
	Machine (old)		260000
	Cash		50000
	Gain on exchange		24000
	(To record the exchange of machine)

When the exchange has commercial substance, the new machine is recorded at the fair value of the old machine plus cash paid and gain or loss is recognized.

Date	General Journal	Debit	Credit
The exchange transaction lacked commercial substance
August 1, 2015	Machine (new) [($260000 - $134000) + $50000]	176000
	Accumulated depreciation-old machine [($24000 x 5) + $14000]	134000
	Machine (old)		260000
	Cash		50000
	(To record the exchange of machine)

When the exchange lacks commercial substance, the new machine is recorded at the book value of the old machine plus cash paid and no gain or loss is recognized.