Chapter 10: Part A and B

Jin Zhang College of Business Administration CSUS

Objectives

Understand the following transactions related to Long-term Assets:

Acquisition Disposition Exchanges

Acquisition

Acquisition cost: all the costs that are normal and necessary to acquire the asset and prepare it of its intended use.
A =L + OE

Cash

PPE

Disposition

Get cash, write off PPE, and recognize gain or loss

=L + OE
GAIN (LOSS )
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A
Cash PPE A/D

Exchanges

Sometimes a company will acquire an asset in exchange for an asset other than cash.

Value the assets received at fair value Gain or Loss is the difference between fair value and book value of the asset given

Exchanges: Example

The Elcorn Company traded it laser equipment for the newer air-cooled ion lasers manufactured by American laser Corporation. The old equipment had a book value of $100,000 (cost of $500,000) less accumulated depreciation of $400,000) and a fair value of $150,000. Elcorn paid American Laser $430,000 in cash. Fair value of new laser=$150,000+430,000 Gain=$150,000-100,000=50,000 Dr. Laser Equipment-NEW Dr. Accumulated Depreciation Cr. Laser Equipment-OLD Cr. Cash Cr. Gain (to balance) 580,000 400,000 500,000 430,000 50,000
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Exchanges: Fair Value not determinable?

How to value new assets if we dont know fair value?

Book value of the value of the assets given up, Plus (or minus) any cash given (received)
530,000 400,000 500,000 430,000

Dr. Laser Equipment-NEW Dr. Accumulated Depreciation Cr. Laser Equipment-OLD Cr. Cash

Exchanges: Exchange Lacks Commercial Substance

To preclude the possibility of companies engaging in exchanges of appreciated assets solely to be able to recognize gains, fair value can only be used in legitimate exchanges that have commercial substance. A nonmonetary exchange is considered to have commercial substance if the company:

expects a change in future cash flows as a result of the exchange, and

that expected change is significant relative to the fair value of the assets exchanged.

Exchanges: Exchange Lacks Commercial Substance (Cont.)

Example: The Elcorn Company traded a tract of land to Sanchez Development For a similar tract of land. The old land had a book value of $2,500,000 and a fair value of $4,500,000. Elcorn paid Sanchez $500,000 in cash. This means the fair value of the land acquired is $5,000,000. Case 1: The transaction has commercial substance
Dr. Land-new Cr. Land-old Cr.Cash Cr. Gain Dr. Land-new Cr. Land-old Cr.Cash 5,000,000
2,500,000 500,000 2,000,000

Case 2: The transaction does not have commercial substance

3,000,000 2,500,000 500,000
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