Detailed Answer
(b) A gain (loss) must be recognized when a nonmonetary
asset is involuntarily converted into monetary assets even if
the company reinvests the monetary assets in replacement nonmonetary
assets. The gain or loss is the difference between the
insurance proceeds received ($3,500) and the carrying value of
the asset destroyed. The unadjusted carrying value ($2,500)
must be adjusted for the capital expenditure ($700) which has
not yet been recorded. When a major component of an asset like
an engine is replaced, the preferred treatment is to take the old
component off the books (with a loss recognized) and record the
new component. When the book value of the component is unknown
(as in this case), the cost of the new component ($700) is
simply debited to the accumulated depreciation account. This
increases the van’s carrying value to $3,200 ($2,500 + $700),
which means the gain is $300 ($3,500 – $3,200). Note that the
$500 invoice should be recorded as repairs expense, and therefore
does not affect the van’s carrying value.