Question

Discuss the basic accounting problem that arises in handling each of the following situations.

(a) Assets purchased by issuance of capital stock.

(b) Acquisition of plant assets by gift or donation.

(c) Purchase of a plant asset subject to a cash discount.

(d) A group of assets acquired for a lump sum.

(e) An asset traded in or exchanged for another asset.

 

 

Answer 1

(a) Assets acquired by issuance of capital stock—when property is acquired by issuance of securities such as common stock, the cost of the property is not measured by par or stated value of such stock. If the stock is actively traded on the market, then the market value of the stock is a fair indication of the cost of the property because the market value of the stock is a good measure of the current cash equivalent price. If the market value of the common stock is not determinable, then the market value of the property should be established and used as the basis for recording the asset and issuance of common stock.

 

 

(b)

Assets acquired by gift or donation—when assets are acquired in this manner a strict cost concept would dictate that the valuation of the asset be zero. However, in this situation, accountants record the asset at its fair market value. The credit would be made to Contribution Revenue or “donated capital.” Contributions received should be credited to revenue unless the contribution is from a governmental unit. Even in that case, we believe that the credit should be to contribution revenue.

 

 

(c)

Cash discount—when assets are purchased subject to a cash discount, the question of how the discount should be handled occurs. If the discount is taken, it should be considered a reduction in the asset cost. Different viewpoints exist, however, if the discount is not taken. One approach is that the discount must be considered a reduction in the cost of the asset. The rationale for this approach is that the terms of these discounts are so attractive that failure to take the discount must be considered a loss because management is inefficient. The other view is that failure to take the discount should not be considered a loss, because the terms may be unfavorable or the company might not be prudent to take the discount. Presently both methods are employed in practice. The former approach is conceptually correct. 

 

 

(d)

Lump sum or basket purchase—sometimes a group of assets are acquired for a single lump sum. When a situation such as this exists, the accountant must allocate the total cost among the various assets on the basis of their relative fair market value.

 

(e)

Trade or exchange of assets—when one asset is exchanged for another asset, the accountant is faced with several issues in determining the value of the new asset. The basic principle involved is to record the new asset at the fair market value of the new asset or the fair market value of what is given up to acquire the new asset, whichever is more clearly evident. However, the accountant must also be concerned with whether the exchange has commercial substance and whether monetary consideration is involved in the transaction. The commercial substance issue rests on whether the expected cash flows on the assets involved are significantly different. In addition, monetary consideration may affect the amount of gain recognized on the exchange under consideration.