I'm Larry Walther, this is principlesofaccounting.com Chapter 11.
In this particular module, we will consider the accounting for
asset exchanges.
Now, asset exchanges involve trading one asset for another, such as if you
have an old piece of equipment and it's traded in conjunction, or for a new piece
of equipment or in conjunction with the purchase of a new piece of equipment.
Sometime businesses might exchange land.
You might wonder why not just sell it and buy what you want.
Sometimes the transactions are motivated by tax considerations.
Some exchange transactions are afforded tax free treatment,
whereas if the asset were actually sold it might involve a taxable transaction.
Now, from a financial accounting point of view,
what we need to do is look at our asset exchange and determine whether it has
commercial substance, or so called commercial substance.
Commercial substance are those transactions where there's a change in
future cash flow that's expected because of the swap.
And those exchanges should be accounted for
based upon fair value accounting considerations.
This has not always been the case.
Once upon a time the question was, were the assets similar or dissimilar?
And a different accounting process was followed based on the answer to
that question.
That's no longer the case, though.
Now we look for the presence of commercial substance, and if present,
we use fair value accounting.
This approach will ordinarily result in the recognition of a gain or loss
because the fair value of the assets will typically differ from their book value.
And so let's look at an example.
Here we have an asset exchange, and a loss is implied in this case.
Company A gives an old truck that had a cost of $1 million but
had 750,000 of accumulated depreciation recorded to date.
Thus, it had a $250,000 book value.
The $1 million cost minus the 750,000 of accumulated depreciation gives
rise to a $250,000 book value.
That truck is being swapped for a boat, in a transaction that's deemed to have
commercial substance, and the boat has a fair value of $150,000.
That also suggests, by the way, in theory, that the truck is worth 150,000.
That is, what's given must have a fair value that's equal to what's received, or
one party would have objected to the transaction.
So for the transaction to have occurred,
there must be perceived relative equality and fair values.
And so, this suggests a loss of $100,000.
We're giving up netbook value of 250,000 in exchange for a $150,000 asset.
Here's the journal entry.
Notice in the journal entry, we removed the old truck from the books.
We're crediting the truck 1 million along with a debit
to its associated accumulated depreciation of 750.
So that removes the old truck from the books.
We record the new equipment, the boat at $150,000, and we need a debit,
a debit indicated a loss, we need a debit to balance that $100,000.
Let's consider a case where we have a gain.
Now I'm assuming that we're giving up the same truck, cost of a million,
accumulated deprecation of 750, a net book value of 250, but we're swapping it for
a much better boat, a boat that's viewed to be worth $350,000 this time.
So the book value of what's given up is 250, the fair value of what's
being recorded or received is 350, we've got 100 gain that's suggested.
And here's the journal entry for that.
Notice we again remove the equipment from the books, credit equipment 1 million,
debit the accumulated depreciation 750.
That removes the old equipment completely from the books.
We establish the boat on the books at its a fair value of 350, and we did a credit
of $100,000 to balance out the entry coincident with the gain recognition.
Sometimes there's boots involved in an exchange transaction.
It describes additional monetary consideration that may accompany
an exchange transaction, boot.
So here's an example now, we're gonna keep the truck again.
We had the $1 million truck with 750,000 of it accumulated depreciation.
Our net book value of 250.
So a $250,000 truck, but we're also throwing in 50,000 of cash.
So in total what we're giving up is consideration that's carried on our books
at 300,000 for the boat that's worth 150 again this time.
Now we've got a loss of $150,000 that is suggested.
Here's the journal entry.
We take the old truck off the books.
Credit equipment a million along with its accumulated depreciation being debited for
750.
We also need to credit the cash being given 50,000.
So there's now 300,000 coming out of our general ledger,
we're putting the new boat on the books at $150,000, debit the boat 150.
And we need a debit or loss to balance out that entry of 150.
So again the debits and credits result in what we logically discussed and
concluded would be appropriate.
If a transaction lacks commercial substance, that is there's no
significant change in cash flows, we have separate accounting rules that apply.
No gain is recorded.
If a loss were implied, we would go ahead and recognize the loss, but
no gain is to be recorded.
An example might be a car dealer, maybe they have green cars, and they
need more red cars in stock or vice versa, so they swap with another dealership.
You're just trading one car for another car,
the only different substantively is the color.
The green cars are simply recorded at the cost of the red cars.
A loss might be recorded if impairment is suggested,
that is if there's a loss implied.
But generally no gain recognition there for
the exchange transactions that are viewed as lacking commercial substance.