Adequate Disclosure: Exchange of Nonmonetary Assets

Non-monetary assets are assets that are physical, tangible type of assets, quite the opposite of cash and cash equivalents. Some examples of non-monetary assets are cars, trucks, buildings, etc. These assets can be traded with another party resulting in a gain or loss. Cash that is paid or received alongside non-monetary asset exchanges is referred to as ‘boot’. All losses and cash paid/received must always be recognized. One of the major benefits in exchanging non-monetary assets is the ability to trade an old asset for a new asset and sometimes cash, depending upon the exchange agreement.

Exchanges may contain commercial substance or lack it. A transaction is said to have commercial substance when it changes an entity’s future cash flows. For example, if you trade a car for a piece of equipment, your cash flow will change, either positively or negatively, however it will generate different cash flows. A car may only bring in x amount of input in your cash flow, while equipment may bring in Y amount of input in your cash flow. Hence, an exchange of a car for a piece of equipment will result in a change of cash flows and the transaction will be accounted for as an exchange that contains commercial substance, accordingly under US GAAP. In contrast, under IFRS an exchange that contains commercial substance is referred to as an exchange of dissimilar assets. All gains must be recognized for exchanges that contain commercial substance.

Example 1A:

Adequate Disclosure, Inc. exchanges an automobile for a building with Inadequate Disclosure, Inc. The exchange contains commercial substance. The automobile exchanged by Adequate Disclosure, Inc. has a book value of $7,000, and a fair value of $10,000. The building has a book value of $1,000 and a fair value of $2,000.

Record the journal entry for Adequate Disclosure Inc.'s books.

First step is to record the old asset at its book value of $7,000. Credit the automobile to remove it off Adequate Disclosure, Inc.'s books.

Second step is to record the acquired asset at its fair value of $2,000. Debit the building to put it on Adequate Disclosure, Inc.'s books.

Third step, use the accounting fundamental theory of “all debits must equal credits”. Since there is a $5,000 gap between the debits and credits, the remainder is attributed to Loss.

Example 1B:

Record the journal entry for Inadequate Disclosure Inc.'s books.

First step is to record the old asset at its book value of $1,000. Credit building to remove it off Inadequate Disclosure Inc.'s books.

Second step is to record the acquired asset at its fair value of $10,000. Debit automobile to put it on Inadequate Disclosure Inc.'s books.

Third step, use the accounting fundamental theory of “all debits must equal credits”. Since there is a $9,000 gap between the debits and credits, the remainder is attributed to Gain

Example 2A:

Record the journal entry for Adequate Disclosure Inc.'s books.

First step is to record the old asset at its book value of $7,000. Credit the automobile to remove it off Adequate Disclosure Inc.'s books.

Second step is to record the acquired asset at its fair value of $2,000. Debit the building to put it on Adequate Disclosure Inc.'s books.

Third Step is to credit the cash paid of $5,000.

Fourth step, use the accounting fundamental theory of “all debits must equal credits”. Since there is a $10,000 gap between the debits and credits, the remainder is attributed to Loss.

Example 2B:

Record the journal entry for Inadequate Disclosure Inc.'s books.

First step is to record the old asset at its book value of $1,000. Credit the building to remove it off Inadequate Disclosure Inc.'s books.

Second step is to record the acquired asset at its fair value of $10,000. Debit the automobile to put it on Inadequate Disclosure Inc.'s books.

Third Step is to debit the cash received of $5,000.

Fourth step, use the accounting fundamental theory of “all debits must equal credits”. Since there is a $14,000 gap between the debits and credits, the remainder is attributed to Gain.

Example 3A:

Record the journal entry for Adequate Disclosure Inc.'s books.

First step is to record the old asset at its book value of $7,000. Credit the automobile account to remove it off Adequate Disclosure, Inc.'s books.

Second step is to record the acquired asset at its fair value of $12,000. Debit the building to put it on Adequate Disclosure, Inc.'s books.

Third step, use the accounting fundamental theory of “debits equaling credits”. Since there is a $5,000 gap between the debits and credits, the remainder is attributed to Gain.

Example 3B:

Adequate Disclosure, Inc. exchanges an automobile for a building with Inadequate Disclosure. The exchange contains commercial substance. The automobile exchanged by Adequate Disclosure has a book value of $7,000, and a fair value of $10,000. The building has a book value of $16,000 and a fair value of $12,000.

Record the journal entry for Inadequate Disclosure Inc.'s books.

First step is to record the old asset at its book value of $16,000. Credit the building to remove it off Inadequate Disclosure Inc.'s books.

Second step is to record the acquired asset at its fair value of $10,000. Debit the automobile to put it on Inadequate Disclosure Inc.'s books.

Third step, use the accounting fundamental theory of “all debits must equal credits”. Since there is a $6,000 gap between the debits and credits, the remainder is attributed to Loss.

Example 4A:

Record the journal entry for Adequate Disclosure Inc.'s books.

First step is to record the old asset at its book value of $7,000. Credit the automobile account to remove it off Adequate Disclosure, Inc.'s books.

Second step is to record the acquired asset at its fair value of 12,000. Debit the building to put it on Adequate Disclosure, Inc.'s books.

Third step is to credit the cash paid of $7,000.

Third step, use the accounting fundamental theory of “debits equaling credits”. Since there is a $2,000 gap between the debits and credits, the remainder is attributed to Loss.

Example 4B:

Adequate Disclosure exchanges an automobile for a building with Inadequate Disclosure. The exchange contains commercial substance. The automobile exchanged by Adequate Disclosure has a book value of $7,000, and a fair value of $10,000. The building has a book value of $16,000 and a fair value of $12,000. Adequate Disclosure pays $7,000 in cash as well.

Record the journal entry for Inadequate Disclosure Inc.'s books.

First step is to record the old asset at its book value of $16,000. Credit the building account to remove it off Inadequate Disclosure Inc.'s books.

Second step is to record the acquired asset at its fair value of $10,000. Debit the automobile to put it on Inadequate Disclosure Inc.'s books.

Third step is to debit the cash received of $7,000.

Third step, use the accounting fundamental theory of “debits equaling credits”. Since there is a $1,000 gap between the debits and credits, the remainder is attributed to Gain.

Exchanges that lack commercial substance are transactions where the same asset is traded for the same asset. An example is if Adequate Disclosure, Inc. trades its old truck to Inadequate Disclosure, Inc. for a new truck. Even though an old truck is exchanged for a new truck, in essence since it’s the same type of asset the cash flows do not change hence it’s a transaction that lacks commercial substance, accordingly under US GAAP. In contrast, under IFRS standards; an exchange that lacks commercial substance is referred to as an exchange of ‘similar’ assets.

Difference: All gains for exchanges that contain commercial substance are recognized; however gains that rise from an exchange that lacks commercial substance are only recognized if ‘boot’ is received and that is subject to recognition rules.

Two Rules that must be taken into consideration when recognizing a gain are:

If the boot received equals or is greater than 25% of the ratio (total cash received/fair value of new asset + plus cash received); all the gain is recognized.

If the boot received is less than 25% of the ratio (total cash received/fair value of new asset + plus cash received), that proportion of the gain is recognized only.

Example 1A:

Adequate Disclosure, Inc. exchanges an old car for a new car with Inadequate Disclosure, Inc. Adequate Disclosure, Inc.'s book value of the car was $3,000 and the fair value was $4,000. Inadequate Disclosure, Inc.'s book value of the car is $4,500, and the fair value was $5,000. Inadequate Disclosure, Inc. pay’s $2,000 in cash as well.

Record the journal entry for Adequate Disclosure Inc.'s books.

First step is to calculate how much of the gain will be recognized. (Total cash received/Fair Value of New Asset + Cash received) $2,000/$7,000 = 28%. Since it is over 25%, the gain will be recognized in full.

Second step is to calculate the gain. Fair Value of the Asset given minus the book value of the asset given. $4,000 - $3,000 = $1,000. The gain will be credited for $1,000.

Third step is to credit the old car for its book value of $3,000.

Fourth step is to debit the amount of cash received of $2,000.

Fifth step, use the accounting fundamental theory of “debits equaling credits”. Since there is a $2,000 gap between the debits and credits, the remainder is attributed to New Car.

Example 1B:

Record the journal entry for Inadequate Disclosure, Inc.'s books.

First step is to credit cash paid of $2,000.

Second step is to credit the old car’s book value of $4,500 and remove it off its books.

Third step is to record the new car’s at its fair value of $4,000. Debit the amount of $4,000.

Fourth step, use the accounting fundamental theory of “debits equaling credits”. Since there is a $2,500 gap between the debits and credits, the remainder is attributed to Loss.

Example 2A:

Record the journal entry for Adequate Disclosure Inc.'s books.

First step is to calculate how much of the gain will be recognized. (Total cash received/Fair Value of New Asset + Cash received) $1,000/$7,000 = 14%. Since it is less than 25%, the gain will be recognized partially.

Second step is to calculate the gain. Fair Value of the Asset given minus the book value of the asset given. $4,000 - $3,000 = $1,000 x 14% = $140. This amount is credited as the total gain recognized.

Third step is to credit the old car for its book value of $3,000.

Fourth step is to debit the amount of cash received of $1,000.

Fifth step, use the accounting fundamental theory of “debits equaling credits”. Since there is a $2,140 gap between the debits and credits, the remainder is attributed to New Car.

Example 2B:

Record the journal entry for Inadequate Disclosure Inc.'s books.

First step is to credit cash paid of $1,000.

Second step is to credit the old car’s book value of $4,500 and remove it off its books.

Third step is to record the new car at its fair value of $4,000. Debit the amount of $4,000.

Fourth step, use the accounting fundamental theory of “debits equaling credits”. Since there is a $1,500 gap between the debits and credits, the remainder is attributed to Loss.

Monday, February 17, 2014

Exchange of Nonmonetary Assets