Nonmonetary Exchange Of Equipment By Montgomery Company

E10 18 Nonmonetary Exchange Montgomery Company Purchased An Electric

E10-18 (Nonmonetary Exchange) Montgomery Company purchased an electric wax melter on April 30, 2013, by trading in its old gas model and paying the balance in cash. The following data relate to the purchase. List price of new melter $15,800 Cash paid 10,000 Cost of old melter (5-year life, $700 residual value) 12,700 Accumulated depreciation old melter (straight-line) 7,200 Secondhand fair value of old melter 5,200 Instructions Prepare the journal entry(ies) necessary to record this exchange, assuming that the exchange (a) has commercial substance, and (b) lacks commercial substance. Montgomerys year ends on December 31, and depreciation has been recorded through December 31, 2012.

Paper For Above instruction

Introduction

The accounting treatment of nonmonetary exchanges is a fundamental aspect of financial accounting, especially when assets are exchanged either with or without commercial substance. These exchanges involve complex considerations to determine the proper recognition and measurement of gains or losses, asset valuation, and subsequent depreciation. Montgomery Company's purchase of a new electric wax melter through a nonmonetary exchange encapsulates these accounting principles and illustrates the distinct journal entries required depending on whether the transaction has commercial substance or not.

Analysis of the Transaction

Before preparing the journal entries, it is essential to analyze the details of the transaction. Montgomery Company traded in its old gas model wax melter, with a book value (cost less accumulated depreciation) of $5,500 ($12,700 cost - $7,200 accumulated depreciation). The fair value of the old melter is estimated at $5,200, which indicates the approximate market valuation at the time of exchange. The new melter’s list price is $15,800, and Montgomery paid $10,000 in cash, meaning the total consideration paid is $15,800, with the remaining balance of $5,800 assumed to be the gain or loss recognition point depending on the scenario.

Scenario (a): Exchange Has Commercial Substance

When the exchange has commercial substance, the asset’s fair value and the economic impact are significant enough to recognize gains or losses immediately. The primary step involves calculating the carrying amount of the old asset and then recognizing the realized gain or loss based on the fair value of the asset given up versus its book value.

Calculation of Book Value of Old Melter: $12,700 - $7,200 = $5,500.

Fair value of old melter (secondhand): $5,200.

Gain on exchange: Fair value of old melter ($5,200) - Book value ($5,500) = -$300 (loss).

Since there is a loss, it will be recognized immediately in the journal entry. The new asset will be recorded at its fair value, which is aligned with the consideration transferred and the fair value of the old asset.

Journal Entry (a):

Dr. Equipment (new melter)       $15,800


Dr. Accumulated Depreciation  $7,200


Dr. Loss on Disposal            $300


Cr. Old Equipment                          $12,700


Cr. Cash                                                $10,000


Cr. Gain on Disposal (if applicable)            $0

Note: The Equipment account is credited for the old asset’s original cost, and the loss recognized adjusts the book based on the fair value discrepancy.

Scenario (b): Exchange Lacks Commercial Substance

In cases where there is no commercial substance, gains are generally deferred, and the new asset is recorded at the book value of the old asset adjusted for any cash received, unless the fair value of the new asset can be reliably measured. Therefore, the focus is on allocating the cost of the new asset based on the book value of the old asset plus any cash paid or received.

In this case, since the fair value of the old asset and the consideration exchanged are similar, and the fair value of the new asset can be reliably measured, the journal entry will be similar to the case with commercial substance but with gain recognition deferred.

Journal Entry (b):

Dr. Equipment (new melter)       $15,800


Dr. Accumulated Depreciation  $7,200


Cr. Old Equipment                          $12,700


Cr. Cash                                                $10,000


Cr. Gain (Deferred)                        $0

Conclusion

In both scenarios, the initial journal entries recognize the acquisition of the new asset and retirement of the old asset. The primary difference between the two lies in the treatment of gains or losses: immediate recognition versus deferral. In practice, the presence of commercial substance determines whether gains are recognized immediately or deferred. Montgomery’s specific circumstances, including fair value measurements, have to be carefully evaluated to ensure accurate financial reporting.

References

  • financial accounting standards board (FASB). (2019). Accounting Standards Codification (ASC) 845, Nonmonetary Transactions.
  • Knudsen, T. (2020). Principles of Accounting. John Wiley & Sons.
  • Horngren, C. T., Sundem, G. L., & Elliott, J. A. (2019). Introduction to Financial Accounting. Pearson.
  • Warfield, T. D. (2021). Financial Accounting and Reporting. McGraw-Hill Education.
  • Revsine, L., Collins, D., & Johnson, M. (2020). Financial Reporting and Analysis. McGraw-Hill Education.
  • Gibson, C. H. (2021). Financial Reporting & Analysis. South-Western College Publishing.
  • Financial Accounting Standards Board (FASB). (2017). ASC 805, Business Combinations.
  • Steve, S. (2018). Advanced Accounting. McGraw-Hill Education.
  • Singleton, T., & Chow, K. (2022). Nonmonetary Transactions: Principles and Practice. Institute of Chartered Accountants.
  • Jones, M. (2020). Modern Financial Accounting. Routledge.

Related Assignments