Question

Pronghorn Ltd. wished to purchase some new equipment for its factory. However, due to recent cash flow difficulties, Pronghorn did not have enough cash on hand to complete the transaction. The equipment’s vendor agreed to accept 1,240 common shares in Pronghorn in exchange for the equipment. Pronghorn’s shares were actively trading at $13.82/share on the day of the exchange. Required a. Prepare the journal entry to record the purchase of the equipment on Pronghorn’s books, assuming that the list price for the equipment was $15,500. b. Prepare the journal entry assuming Pronghorn was a private company whose shares do not trade actively and that the equipment had a quoted fair value of $18,277.

Answer 1

• Companies need long term fixed assets (land, building, equpments and vehicles etc.) to carry out various business activities. One way to acquire these assets is to purchase them for cash and another way is to acquire them in exchange of company’s stock. Issuing stock for non-cash tangible and intangible assets is common among companies but valuation often becomes a major problem in such transactions. The general rule is to record these transactions on the basis of fair market value of the non-cash asset acquired or the fair market value of the stock issued whichever can be more clearly and reliably determined.
• If the fair market value of the asset to be received or the stock to be issued is not readily determinable, the board of directors or management can determine a value that is fair in their opinion. They can also seek the assistance of a qualified independent valuer for this purpose.