Car exchange is a typical example of asset exchanges where a car is traded for another. The underlying issue in such an exchange is the value of one care compared to the other by comparing the book value and the depreciation. To determine a car exchange is a profit or loss the dealership needs to determine the book value of the assets (car) by subtracting the amount of accumulated depreciation from the cost of the asset.
The fair value approach is useful for car dealership and any other firm that is involved in the exchange of assets. An exchange that has a commercial substance which is either a gain or a loss will have an impact on the book value of the traded or swapped car. The transaction involves the liquidation of one car and replacement by another.
An example of a loss is the car dealership exchanging car A, $100,000 price or cost and with an accumulated depreciation of $75,000, with Car B. The book value of car A is $25,000 ($100,000 – $75,000) The fair value of the car is $15,000 which is also considered as the cost for the other car (Car B). Car B should be recorded at fair value as this amount is less than the book value for Car A, thus a loss of $10,000 recorded due to the difference.
An example of a gain is the car dealership exchanging Car A, $100,000 price and with an accumulated depreciation of $75,000, with Car B. The fair value of Car A is $35,000, which is considered to be the fair value of Car B. The book value of Car A is $25,000 which is lower than the fair value of Car B thus the difference of $10,000 is a gain.