Question

Why don't we record gains under the exception to fair value method?

When we record a non-monetary exchange that lacks commercial substance, we use the carrying amount of the old asset plus any cash consideration for the value of the new asset. Why don't we record gains or losses under this method? My prof says we never record gains but sometimes we record losses if the deal wasn't fair. Why?

Answer 1

Answer:-

In case of non-monetary exchange that lacks commercial substance, what actually happens is,

If an exchange has no commercial substance,

the accounting treatment will depend on the circumstances.

lets take the simplest circumstance is when two assets are traded ( here Comercial substance is Missing) with no cash payment from either side.

In this case, the new asset is recorded at the carrying amount of the old asset (original cost minus accumulated depreciation).

If cash is given along with the old asset, the new asset is similarly recorded at the carrying amount of the old asset plus the amount of money paid.

Now Answer to your main doubt whether to recognize gain or not in no comercial transactions or transactions which lack comercial substance :-

If cash is received in an exchange that has no commercial substance, part of the realized gain is recognized if the cash is less than 25% of the total consideration received.

Let us take an Example :-

If a machine with a fair value of $20,000 and a carrying value of $15,000 is exchanged for a similar machine and $3,000 in cash was also received from such exchange,

then actual Gain = 20000-15000 = $5000

since the cash is 15% ($3,000 ÷ $20,000) of the fair value of the old asset, 15% ($750 = $5,000 x 15%) of the realized gain will actually be recognized.

If cash is more than 25% of the total assets received, the exchange is treated as a cash sale and the entire difference between the fair value and carrying amount of the old asset is booked as an income statement gain.

Some concepts in accounting needs to be understand 1st, to completely understand the answer of this question.

Under the prudence concept,

we do not overestimate the amount of revenues recognized or underestimate the amount of expenses. You should also be conservative in recording the amount of assets, and not underestimate liabilities

As per Fair Value method , we do not record gains as to collectibility of certain gains are not sure.