Question

Case A.

Kapono Farms exchanged an old tractor for a newer model. The old tractor had a book value of $19,500 (original cost of $43,000 less accumulated depreciation of $23,500) and a fair value of $10,500. Kapono paid $35,000 cash to complete the exchange. The exchange has commercial substance.

Case B.

Kapono Farms exchanged 100 acres of farmland for similar land. The farmland given had a book value of $575,000 and a fair value of $850,000. Kapono paid $65,000 cash to complete the exchange. The exchange has commercial substance.

10-8 (Algo) Part 2

1.What is the amount of gain or loss that Kapono would recognize on the exchange of the land?

2. Assume the fair value of the farmland given is $460,000 instead of $850,000. What is the amount of gain or loss that Kapono would recognize on the exchange? What is the initial value of the new land?

3. Assume the same facts as Requirement 1 and that the exchange lacked commercial substance. What is the amount of gain or loss that Kapono would recognize on the exchange? What is the initial value of the new land?

Answer 1

1. When the future cash flow is expected to change because of a certain transaction, it is said to have a Commercial Substance. The firms follow the Fair-Value Approach whenever the transactions have commercial substance which eventually leads to a gain or loss because the fair value will be different from the book value. Book Value of the land = $575,000 Fair Value Of the Land = $850,000 Actual Profit on Transaction = $850,000 – ( $575,000 + $65,000 ) = $850,000 – $640,000 = $210,000 This transaction is accompanied by a boot(Additional Monetary Consideration) of $65,000 The Journal Entry of the exchange will be as follows : No. CREDIT DEBIT $850,000 ACCOUNT Land (New) To Cash To Profit To Land (Old) ( To remove old land account and set up new land account at its fair value) $65,000 $210,000 $575,000 2. We have been asked to assume that the Fair Value Of Land = $460,000 Book Value Of the Land = $575,000 As the book value is more than the fair value, the entity will record a loss Loss on transaction = (Book Value + Additional Monetary Consideration) - Fair Value = ( $575,000 + $65,000 ) - $460,000 = $640,000 - $460,000 Loss that Kapono will recognize = $180,000 Initial Value of the land will be its fair value and that is $460,000

3. Whenever the exchange lacks commercial substance, the assets are recorded at their book value instead of their fair value and no gain or loss is recognized. To facilitate the transaction, Kapono is paying an additional monetary consideration of $65,000. Therefore, this payment will also be included to the initial value of newly purchased land Thus, initial value of the new land = BOOK VALUE OF OLD LAND + ADDITIONAL CONSIDERATION = $575,000 + $65,000 Initial Value Of New Land = $640,000