Chapter 10, Problem 6P

1.

To determine

Journalize entries to record each acquisition.

Explanation of Solution

Property, Plant, and Equipment:

Property, Plant, and Equipment refers to the fixed assets, having a useful life of more than a year that is acquired by a company to be used in its business activities, for generating revenue.

Journal entry:

Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Accounting rules for Journal entries:

• To record increase balance of account: Debit assets, expenses, losses and credit liabilities, capital, revenue and gains.
• To record decrease balance of account: Credit assets, expenses, losses and debit liabilities, capital, revenue and gains

Prepare journal entries:

Date			Account titles and explanation	Debit ($)	Credit ($)
	a		Machine(new) (1)	34,000
			Accumulated depreciation for machine (2)	15,000
			Machine (old)		40,000
			Cash		4,000
			Gain on exchange (3)		5,000
			( To record the machine acquired by paying cash and giving up machine)
	b		Machine (new) (4)	34,000
			Accumulated depreciation for machine (5)	7,000
			Loss on exchange (6)	3,000
			Machine (old)		40,000
			Cash		4,000
			( To record the machine surrendered)
	c		Machine (new) (7)
			Accumulated depreciation for machine (8)
			Cash
			Machine (old)
			Gain on exchange (9)
			( To record the machine acquired by receiving cash and giving up machine)
	d		Machine (new) (10)	27,000
			Accumulated Depreciation for Machine (11)	9,000
			Loss on Exchange (12)	4,000
			Cash	5,000
			Machine (old)		45,000
			( To record the machine surrendered)
	e		Machine (new) (13)	90,000
			Accumulated Depreciation for Machine (14)	70,000
			Machine (old)		150,000
			Gain on Exchange (15)		10,000
			( To record the machine acquired by paying cash and giving up machine)
	f		Machine (new) (16)	90,000
			Accumulated Depreciation for  Machine (17)	56,000
			Loss on Exchange (18)	4,000
			Machine (old)		150,000
			( To record the machine surrendered)
	g		Building (19)	200,000
			Gain on Exchange  (20)		70,000
			Land		130,000
			( To record the building acquired in exchange for land)
	h		Building (21)	230,000
			Gain on Exchange (22)		70,000
			Cash		30,000
			Land		130,000
			( To record the building acquired in exchange for land and paid cash)
	i		Building  (23)	180,000
			Cash	20,000
			Gain on Exchange (24)		70,000
			Land		130,000
			( To record the building acquired in exchange for land and received cash)

Table (1)

Working notes:

Transaction a:

(1) Calculate the cost of the equipment:

$\begin{array}{c}\begin{array}{l}\text{Cost}\text{of}\text{the}\\ \text{Machine (new)}\end{array}\}\text{=}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered+Cash}\text{paid}\\ \text{=\$30,000+\$4,000}\\ \text{=\$34,000}\end{array}$

(2) Calculate the accumulated depreciation of machine:

$\begin{array}{c}\text{Accumulated}\text{depreciation}\text{=}\text{Original}\text{cost}-\text{Book}\text{value}\\ \text{=\$40,000}-\text{\$25,000}\\ \text{=\$15,000}\end{array}$

(3) Calculate the gain on exchange:

$\begin{array}{c}\text{Gain}\text{on}\text{exchange}\text{=}\left(\begin{array}{l}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered}-\\ \text{Book}\text{value}\text{of}\text{asset}\text{surrendered}\end{array}\right)\\ \text{=\$30,000}-\text{\$25,000}\\ \text{=\$5,000}\end{array}$

Transaction b:

(4) Calculate the cost of the equipment:

$\begin{array}{c}\begin{array}{l}\text{Cost}\text{of}\text{the}\\ \text{Machine (new)}\end{array}\}\text{=}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered+Cash}\text{paid}\\ \text{=\$30,000+\$4,000}\\ \text{=\$34,000}\end{array}$

(5) Calculate the accumulated depreciation of machine:

$\begin{array}{c}\text{Accumulated}\text{depreciation}\text{=}\text{Original}\text{cost}-\text{Book}\text{value}\\ \text{=\$40,000}-\text{\$33,000}\\ \text{=\$7,000}\end{array}$

(6) Calculate the loss on exchange:

$\begin{array}{c}\text{Loss}\text{on}\text{exchange}\text{=}\left(\begin{array}{l}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered}-\\ \text{Book}\text{value}\text{of}\text{asset}\text{surrendered}\end{array}\right)\\ \text{=\$30,000}-\text{\$33,000}\\ \text{=(\$3,000)}\end{array}$

Transaction c:

(7) Calculate the cost of the equipment:

$\begin{array}{c}\begin{array}{l}\text{Cost}\text{of}\text{the}\\ \text{Machine (new)}\end{array}\}\text{=}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendere}-\text{Cash}\text{received}\\ \text{=\$32,000}-\text{\$5,000}\\ \text{=\$27,000}\end{array}$

(8) Calculate the accumulated depreciation of machine:

$\begin{array}{c}\text{Accumulated}\text{depreciation}\text{=}\text{Original}\text{cost}-\text{Book}\text{value}\\ \text{=\$45,000}-\text{\$20,000}\\ \text{=\$25,000}\end{array}$

(9) Calculate the gain on exchange:

$\begin{array}{c}\text{Gain}\text{on}\text{exchange}\text{=}\left(\begin{array}{l}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered}-\\ \text{Book}\text{value}\text{of}\text{asset}\text{surrendered}\end{array}\right)\\ \text{=\$32,000}-\text{\$20,000}\\ \text{=\$12,000}\end{array}$

Transaction d:

(10) Calculate the cost of the equipment:

$\begin{array}{c}\begin{array}{l}\text{Cost}\text{of}\text{the}\\ \text{Machine (new)}\end{array}\}\text{=}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered}-\text{Cash}\text{received}\\ \text{=\$32,000}-\text{\$5,000}\\ \text{=\$27,000}\end{array}$

(11) Calculate the accumulated depreciation of machine:

$\begin{array}{c}\text{Accumulated}\text{depreciation}\text{=}\text{Original}\text{cost}-\text{Book}\text{value}\\ \text{=\$45,000}-\text{\$36,000}\\ \text{=\$9,000}\end{array}$

(12) Calculate the loss on exchange:

$\begin{array}{c}\text{Loss}\text{on}\text{exchange}\text{=}\left(\begin{array}{l}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered}-\\ \text{Book}\text{value}\text{of}\text{asset}\text{surrendered}\end{array}\right)\\ \text{=\$32,000}-\text{\$36,000}\\ \text{=(\$4,000)}\end{array}$

Transaction e:

(13) Calculate the cost of the equipment:

$\begin{array}{c}\begin{array}{l}\text{Cost}\text{of}\text{the}\\ \text{Machine (new)}\end{array}\}\text{=}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered}\\ \text{=\$90,000}\end{array}$

(14) Calculate the accumulated depreciation of machine:

$\begin{array}{c}\text{Accumulated}\text{depreciation}\text{=}\text{Original}\text{cost}-\text{Book}\text{value}\\ \text{=\$150,000}-\text{\$80,000}\\ \text{=\$70,000}\end{array}$

(15) Calculate the gain on exchange:

$\begin{array}{c}\text{Gain}\text{on}\text{exchange}\text{=}\left(\begin{array}{l}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered}-\\ \text{Book}\text{value}\text{of}\text{asset}\text{surrendered}\end{array}\right)\\ \text{=\$90,000}-\text{\$80,000}\\ \text{=\$10,000}\end{array}$

Transaction f:

(16) Calculate the cost of the equipment:

$\begin{array}{c}\begin{array}{l}\text{Cost}\text{of}\text{the}\\ \text{Machine (new)}\end{array}\}\text{=}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered}\\ \text{=\$90,000}\end{array}$

(17) Calculate the accumulated depreciation of machine:

$\begin{array}{c}\text{Accumulated}\text{depreciation}\text{=}\text{Original}\text{cost}-\text{Book}\text{value}\\ \text{=\$150,000}-\text{\$94,000}\\ \text{=\$56,000}\end{array}$

(18) Calculate the loss on exchange:

$\begin{array}{c}\text{Loss}\text{on}\text{exchange}\text{=}\left(\begin{array}{l}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered}-\\ \text{Book}\text{value}\text{of}\text{asset}\text{surrendered}\end{array}\right)\\ \text{=\$90,000}-\text{\$94,000}\\ \text{=(\$4,000)}\end{array}$

Transaction g:

(19) Calculate the cost of the building:

$\begin{array}{c}\begin{array}{l}\text{Cost}\text{of}\text{the}\\ \text{Building}\end{array}\}\text{=}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered}\\ \text{=\$200,000}\end{array}$

(20) Calculate the gain on exchange:

$\begin{array}{c}\text{Gain}\text{on}\text{exchange}\text{=}\left(\begin{array}{l}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered}-\\ \text{Book}\text{value}\text{of}\text{asset}\text{surrendered}\end{array}\right)\\ \text{=\$200,000}-\text{\$130,000}\\ \text{=\$70,000}\end{array}$

Transaction h:

(21) Calculate the cost of the building:

$\begin{array}{c}\begin{array}{l}\text{Cost}\text{of}\text{the}\\ \text{Building}\end{array}\}\text{=}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered+Cash}\text{paid}\\ \text{=\$200,000+\$30,000}\\ \text{=\$230,000}\end{array}$

(22) Calculate the gain on exchange:

$\begin{array}{c}\text{Gain}\text{on}\text{exchange}\text{=}\left(\begin{array}{l}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered}-\\ \text{Book}\text{value}\text{of}\text{asset}\text{surrendered}\end{array}\right)\\ \text{=\$200,000}-\text{\$130,000}\\ \text{=\$70,000}\end{array}$

Transaction i:

(23) Calculate the cost of the building:

$\begin{array}{c}\begin{array}{l}\text{Cost}\text{of}\text{the}\\ \text{Building}\end{array}\}\text{=}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered}-\text{Cash received}\\ \text{=\$200,000}-\text{\$20,000}\\ \text{=\$180,000}\end{array}$

(24) Calculate the gain on exchange:

$\begin{array}{c}\text{Gain}\text{on}\text{exchange}\text{=}\left(\begin{array}{l}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered}-\\ \text{Book}\text{value}\text{of}\text{asset}\text{surrendered}\end{array}\right)\\ \text{=\$200,000}-\text{\$130,000}\\ \text{=\$70,000}\end{array}$

2.

To determine

Record journal entries assuming that item e does not have commercial substance.

Explanation of Solution

Prepare journal entry:

Date		Account titles and explanation	Debit ($)	Credit ($)
		Machine(new)	80,000
		Accumulated depreciation for machine	70,000
		Machine (old)		150,000

Table (12)

• Machine (new) is an asset and it is increased. Therefore, debit machine (new) account by $80,000.
• Accumulated depreciation for machine is a contra asset and it is decreased. Therefore, debit Accumulated depreciation for machine account by $70,000.
• Machine (old) is an asset and it is decreased. Therefore, credit machine (old) account by $150,000.

Note: “Item e” does not have commercial substance therefore, the gain is deferred.

Working notes:

(25) Calculate the cost of the machine (new):

$\begin{array}{c}\text{Cost}\text{of}\text{machine}\text{(new)=}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered}-\text{Gain}\text{on}\text{exchange}\\ \text{=\$90,000}-\text{\$10,000}\text{(26)}\\ \text{=\$80,000}\end{array}$

(26) Calculate gain on exchange:

$\begin{array}{c}\text{Gain}\text{on}\text{exchange}\text{=}\left(\begin{array}{l}\text{Fair}\text{value}\text{of}\text{asset}\text{surrendered}-\\ \text{Book}\text{value}\text{of}\text{asset}\text{surrendered}\end{array}\right)\\ \text{=\$90,000}-\text{\$80,000}\\ \text{=\$10,000}\end{array}$

3.

To determine

Explain the justification of different accounting between the exchanges having commercial substance versus the exchanges without commercial substance.

Explanation of Solution

The economic condition of the both companies change and the expected cash flows in future moderately change due to exchange, thus difference accounting is justified, if an exchange is having commercial substance. So, that gains and losses are identified during the time of exchange. On the other hand, if an exchange is without a commercial substance, both of the companies are in the equal economic position. Thus, while the principle of “conservatism” permits recognition of losses, a company will defer gains unless a transaction occurs to modify the cash flow of the company.