Case A. Kapono Farms exchanged an old tractor for a newer model. The old tractor had a book value of $13,500 (original cost of $31,000 less accumulated depreciation of $17,500) and a fair value of $9,300. Kapono paid $23,000 cash to complete the exchange. The exchange has commercial substance. Required: 1. What is the amount of gain or loss that Kapono would recognize on the exchange? What is the initial value of the new tractor? 2. Assume the fair value of the old tractor is $17,000 instead of $9,300. What is the amount of gain or loss that Kapono would recognize on the exchange? What is the initial value of the new tractor?

Note: When a transaction has commercial substance, it means it is marketable and can be sold at fair value provided, in that case book value of old asset to be sold is not considered for calculating initial cost of new asset.

Since the transaction has commercial substance

Fair value of the old tractor will be considered.

Cost of new tractor = Cash paid + Fair value of old tractor

= $23,000 + $9,300 = $32,300

1. Gain or loss on exchange = Exchange value of old tractor - Book value of old tractor

Exchange value of old tractor = Fair value of old tractor as transaction had commercial substance = $9,300

Gain or loss on exchange = $9,300 - $13,500 = -$4,200 (Loss)

Initial value of the new tractor = Cost of new tractor as computed above = $32,300

2. In case the fair value of old tractor = $17,000

Then

Gain or loss on exchange = Exchange value of old tractor - Book value of old tractor = $17,000 - $13,500 = $3,500 Gain

because exchange value of old tractor = Fair value of old tractor as transaction had commercial substance

Initial value of the new tractor = Cost of new tractor = $23,000 + $17,000 = $40,000

Final Answer is as follows:

1. Gain or loss on exchange = $4,200 (Loss)

Initial value of the new tractor = $32,300

2. In case the fair value of old tractor = $17,000

Gain or loss on exchange = $3,500 Gain

Initial value of the new tractor = $40,000