Question

Bob the Builder purchased a land and building in Year 6 for $4,000,000. $1.6 million of the purchase price was allocated to the land, and the balance to the building. At the time of the purchase it was estimated that the building would have a useful life of 40 years but no residual value.

In Year 18, Bob exchanged the land and building for a piece of undeveloped land. The fair market value of the assets given up was estimated to be $6.2 million and the fair value of the land to be received was $6.1 million. To make up the difference in the fair values of the assets exchanged, Bob also received $100,000 cash

Bob depreciates his buildings using the straight-line method. Bob adopts half-year convention for depreciation.

(1) Prepare the journal entry to record the exchange of the asset in Year 18, for Bob the Builder, assuming that the transaction has commercial substance (general case).

(2) Prepare the journal entry to record the exchange of the asset in Year 18, for Bob the Builder, assuming that the transaction lacks commercial substance (exception case).

Answer 1

(a)

Book value at end of 18th year

Number of years = 18-6 = 12 years

Depreciation on building = (Cost - Salvage value)/Useful life = 2.4 million/40 = 60,000

Carrying balance of building on date of exchange = 2.4 million - 60,000 x 12

= 1,680,000

Carrying value of both = 1,680,000 + 1,600,000 = 3,280,000

(As it is given as half year convention, the depreciation is taken for half year in the first year and year of exchange)

(The transfer must be recognised at the fair value of asset given up or at the fair market value of asset acquired, whichever is more reliable. We have taken the asset at fair value of asset and resultant gain is recognised)

Undeveloped land a/c $6,100,000

Cash a/c $100,000

Accumulated depreciation a/c $720,000

To Building a/c $2,400,000

To Land a/c $1,600,000

To Exchange gain a/c $2,920,000

(The asset recognised and exchange gain accounted)

(The fair value of Asset given up is taken as more reliable and accounted)

(b)

Undeveloped land a/c $3,227,097

Cash a/c $100,000

Accumulated depreciation a/c $720,000

To Building a/c $2,400,000

To Land a/c $1,600,000

To Exchange gain a/c $47,097

(The exchange gain is recognised upto the portion of cash receievd as part of gain due to exchange)

(In some countries, the gain is recorded in full i.e., 100,000 and the asset is recognised at $3,280,000)

Exchange gain = 100,000/(6.2 million) x [ 6.2 million - 3,280,000 ]

= $47,097

Note : Since the country of the persons is not given, accounting is done based on international accounting standards.