Question

Two independent companies, Denver and Bristol, each own a warehouse, and they agree to an exchange in which no cash changes hands. The following information for the two warehouses is available:

	Denver	Bristol
Cost	$105,000	$55,500
Accumulated depreciation	53,000	22,000
Fair value	45,000	45,000

Required:

1.	Assuming the exchange has commercial substance, prepare journal entries for Denver and Bristol to record the exchange.
2.	Assuming the exchange does not have commercial substance, prepare journal entries for Denver and Bristol to record the exchange.
3.	Next Level What is the justification of accounting for the exchange differently when the exchange has commercial substance versus when it does not?

Answer 1

1. If the exchange has commercial substance I.e future cash flows are expected to change then the exchange should be recorded at fair value

In books of Denver

Accumulated depreciation a/c Dr 53000

Asset a/c Dr (new) 45000

Loss a/c Dr 7000

To asset a/c (old). 105000

In books of Bristol

Accumulated depreciation a/c Dr 22000

Asset a/c Dr (new). 45000

To asset a/c (old). 55500

To profit a/c 11500

2. If the exchange does not have commercial substance

In the books of Denver

Asset a/c Dr (new) 52000

Accumulated depreciation a/c 53000

To asset a/c (old ). 105000

In the books of Bristol

Asset a/c Dr (new) 33500

Accumulated depreciation a /c Dr 22000

To asset a /c (old). 55500

3. When the asset has commercial substance that means cash flows are affected with the outgoing and incoming of asset and will effect the value of the business, so the general practice is to record the asset at fair value which will record true value of the asset and the associated cash flows associated with it help in financial analysis like internal rate of return. Whereas where the exchange does not have commercial substance value of the asset is recorded at book value.

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