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Book value. An assets original cost, less any depreciation that has been subsequently incurred. Boot. The monetary portion of an exchange involving similar assets. Capitalization limit. The minimum threshold of expenditure beyond which a purchased asset will be recorded as a fixed asset. Below this limit, the expenditure will be recorded as an expense. Depreciation. Both the decline in value of an asset over time, as well as the gradual expensing of an asset over time, roughly in accordance with its level of usage or decline in value through that period. Development. The enhancement of existing products or processes, or the creation of entirely new ones. Fixed assets. An item with a longevity greater than one year, and which exceeds a companys minimum capitalization limit. It is not purchased with the intent of immediate resale, but rather for productive use within a company. Impairment. When the carrying amount of a fixed asset exceeds its net present value. This condition usually requires a write-down in the recorded value of the asset. Intangible assets. A nonphysical asset with a life greater than one year. Examples are goodwill, patents, trademarks, and copyrights. Leasehold improvements. Improvements made by a company to its leased properties, exceeding the corporate capitalization limit, that have an expected life of greater than one year. Research. The planned search for the discovery of new knowledge. Retirement. The stoppage of regular use of a fixed asset. This event is typically followed by the idling, disposal, or sale of the asset. CONCEPTS AND EXAMPLES1 Fixed AssetsPurchases When a company purchases a fixed asset, there are a number of expenditures it is allowed to include in the capitalized cost of the asset. These costs include the sales tax and ownership registration fees (if any). Also, the cost of all freight, insurance, and duties required to bring the asset to the company can be included in the capitalized cost. Further, the cost required to install the asset can be included. Installation costs include the cost to test and break in the asset, which can include the cost of test materials. If a fixed asset is acquired for nothing but cash, then its recorded cost is the amount of cash paid. However, if the asset is acquired by taking on a payable, such as a stream of debt payments (or taking over the payments that were initially to be made by the seller of the asset), then the present value of all future payments yet to be made must also be rolled into the recorded asset cost. If the stream of future payments contains no stated interest rate, then one must be imputed based on market rates when making the present value calculation. If the amount of the payable is not clearly evident at the time of purchase, then it is also admissible to record the asset at its fair market value. If an asset is purchased with company stock, one may assign a value to the asset acquired based on either the fair market value of the stock or the asset, whichever is more easily determinable.

Much of the information in this section is adapted with permission from Chapter 16 of Bragg, Accounting Reference Desktop (John Wiley & Sons, Inc., Hoboken, NJ, 2002).

Chapter 6 / Long-Lived Assets

Example of an asset acquired with stock

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The St. Louis Motor Car Company issues 500 shares of its stock to acquire a sheet metal bender. This is a publicly held company, and on the day of the acquisition its shares were trading for $13.25 each. Since this is an easily determinable value, the cost assigned to the equipment is $6,625 (500 shares times $13.25/share). A year later, the company has taken itself private, and chooses to issue another 750 shares of its stock to acquire a router. In this case, the value of the shares is no longer so easily determined, so the company asks an appraiser to determine the routers fair value, which she sets at $12,000. In the first transaction, the journal entry was a debit of $6,625 to the fixed asset equipment account and a credit of $6,625 to the common stock account, while the second transaction was to the same accounts, but for $12,000 instead.

If a company obtains an asset through an exchange involving a dissimilar asset, it should record the incoming asset at the fair market value of the asset for which it was exchanged. However, if this fair value is not readily apparent, the fair value of the incoming asset can be used instead. If no fair market value is readily obtainable for either asset, then the net book value of the relinquished asset can be used.
Example of an exchange for a dissimilar asset The Dakota Motor Company swaps a file server for an overhead crane. Its file server has a book value of $12,000 (net of accumulated depreciation of $4,000), while the overhead crane has a fair value of $9,500. The company has no information about the fair value of its file server, so Dakota uses its net book value instead to establish a value for the swap. Dakota recognizes a loss of $2,500 on the transaction, as noted in the following entry:
Factory equipment Accumulated depreciation Loss on asset exchange Factory equipment 9,500 4,000 2,000 16,000

A common transaction is for a company to trade in an existing asset for a new one, along with an additional payment that covers the incremental additional cost of the new asset over that of the old one being traded away. The additional payment portion of this transaction is called the boot. When the boot comprises at least 25% of the exchanges fair value, both entities must record the transaction at the fair value of the assets involved. If the amount of boot is less than 25% of the transaction, the party receiving the boot can recognize a gain in proportion to the amount of boot received.
Example of an asset exchange with at least 25% boot The Dakota Motor Company trades in a copier for a new one from the Fair Copy Company, paying an additional $9,000 as part of the deal. The fair value of the copier traded away is $2,000, while the fair value of the new copier being acquired is $11,000 (with a book value of $12,000, net of $3,500 in accumulated depreciation). The book value of the copier being traded away is $2,500, net of $5,000 in accumulated depreciation. Because Dakota has paid a combination of $9,000 in cash and $2,500 in the net book value of its existing copier ($11,500 in total) to acquire a new copier with a fair value of $11,000, it must recognize a loss of $500 on the transaction, as noted in the following entry:
Office equipment (new asset) Accumulated depreciation Loss on asset exchange Office equipment (asset traded away) Cash 11,000 5,000 500 7,500 9,000

On the other side of the transaction, Fair Copy is accepting a copier with a fair value of $2,000 and $9,000 in cash for a replacement copier with a fair value of $11,000, so its journal entry is as follows:

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Cash Office equipment (asset acquired) Loss on sale of asset Office equipment (asset traded away) 9,000 3,500 1,000 15,500

Example of an asset exchange with less than 25% boot As was the case in the last example, the Dakota Motor Company trades in a copier for a new one, but now it pays $2,000 cash and trades in its old copier, with a fair value of $9,000 and a net book value of $9,500 after $5,000 of accumulated depreciation. Also, the fair value of the copier being traded away by Fair Copy remains at $11,000, but its net book value drops to $10,000 (still net of accumulated depreciation of $3,500). All other information remains the same. In this case, the proportion of boot paid is 18% ($2,000 cash, divided by total consideration paid of $2,000 cash plus the copier fair value of $9,000). As was the case before, Dakota has paid a total of $11,500 (from a different combination of $9,000 in cash and $2,500 in the net book value of its existing copier) to acquire a new copier with a fair value of $11,000, so it must recognize a loss of $500 on the transaction, as noted in the following entry:
Office equipment (new asset) Accumulated depreciation Loss on asset exchange Office equipment (asset traded away) Cash 11,000 5,000 500 14,500 2,000

The main difference is on the other side of the transaction, where Fair Copy is now accepting a copier with a fair value of $9,000 and $2,000 in cash in exchange for a copier with a book value of $10,000, so there is a potential gain of $1,000 on the deal. However, because it receives boot that is less than 25% of the transaction fair value, it recognizes a pro rata gain of $180, which is calculated as the 18% of the deal attributable to the cash payment, multiplied by the $1,000 gain. Fair Copys journal entry to record the transaction is as follows:
Cash Office equipment (asset acquired) Accumulated depreciation Office equipment (asset traded away) Gain on asset transfer 2,000 8,180 3,500 13,500 180

In this entry, Fair Copy can recognize only a small portion of the gain on the asset transfer, with the remaining portion of the gain being netted against the recorded cost of the acquired asset.

If a group of assets are acquired through a single purchase transaction, the cost should be allocated among the assets in the group based on their proportional share of their total fair market values. The fair market value may be difficult to ascertain in many instances, in which case an appraisal value or tax assessment value can be used. It may also be possible to use the present value of estimated cash flows for each asset as the basis for the allocation, though this measure can be subject to considerable variability in the foundation data, and also requires a great deal of analysis to obtain.
Example of a group asset acquisition The Dakota Motor Company acquires three machines for $80,000 as part of the Chapter 7 liquidation auction of a competitor. There is no ready market for the machines. Dakota hires an appraiser to determine their value. She judges machines A and B to be worth $42,000 and $18,000, respectively, but can find no basis of comparison for machine C, and passes on an appraisal for that item. Dakotas production manager thinks the net present value of cash flows arising from the use of machine C will be about $35,000. Based on this information, the following costs are allocated to the machines: