Accounting for Nonmonetary Exchange
Nonmonetary Exchange is the process that company exchange its own assets with other assets excluding cash and cash equivalent. It means both companies agree to exchange their assets with each other. It can be similar assets that have similar value.
The sale and purchase of assets involve the cash settlement, so it is easy to calculate gain and loss from the transaction. But when the assets are exchanged without cash settlement, we have to determine the gain and loss of the transaction base on the fair value of both assets.
The cost of assets receive will be calculated base on:
- Fair value of asset transfer out
- Fair value of asset receive if the market value of assets transfer out is not measure reliable
- Book value of assets transfers out if there is no commercial substance from the transaction.
The commercial substance is the concept in which the company’s future cash flow changes due to the transaction. The transaction is considered to have commercial substance unless it can impact the company’s future cash flow.
Example
Company ABC owns a vehicle that has a book value of $ 45,000, Costs $ 100,000, and accumulated depreciation of $ 55,000. As the company rarely uses the vehicle and staff take good care, its market value is $ 60,000 base on external appraisal. Management agrees to exchange the vehicle with machinery. We do not know exactly how much the value of this machinery, but the owner claims that its value is $ 70,000.
We record the cost of the acquired machine base on the fair value of the transferred asset as it can be measured reliable by the external appraisal.
Gain on Exchange = Market Value – Book value = 60,000 – 45,000 = $ 15,000
ABC company should make journal entry by debit cost of acquired machinery, accumulated depreciation of vehicle and credit cost of vehicle and gain on exchange.
| Account | Debit | Credit |
|---|---|---|
| Cost _ Machinery | 60,000 | |
| Acc.Dep _ Vehicle | 55,000 | |
| Cost _ Vehicle | 100,000 | |
| Gain on Exchange | 15,000 |
ABC will recognize cost of new machinery into its balance sheet. At the same time, it remove both cost and accumulated depreciation of transferred assets (vehicle). Gain on exchage is based on above calculation, which will present in income statement.
We ignore the value of the acquired asset as it is less reliable. We have enough data related to the market value of the transferred asset.
Example 2
Company EFG owns a piece of machinery that has costs of $ 800,000 and accumulated depreciation of $ 100,000. Due to the nature of the asset, we are not able to estimate the market value.
The company comes to the agreement to exchange machine with a piece of land which has a market value of $ 900,000. We get this value from the local real estate agency which is considered reliable.
We do not have the fair value of transferred assets (machinery). So the value of a received asset (land) will base on its market value which is $ 900,000. The market value of received asset is higher than the book value of a transferred asset ($ 800,000 – $ 100,000), so we will have gain from the transaction.
Gain on Exchange = $ 900,000 – $ 700,000 = $ 200,000
Company EFG needs to make journal entry by debiting cost of land & Accumulated depreciation of machine and credit cost of machine and gain on exchange.
| Account | Debit | Credit |
|---|---|---|
| Cost _ Land | 900,000 | |
| Acc.Dep _ Machine | 100,000 | |
| Cost _ Machine | 800,000 | |
| Gain on Exchange | 200,000 |
This journal entry will remove both cost and accumulated depreciation of machine. It also record the new land into balance sheet along side with gain on exchange.
Example 3
Company XYZ owns a car which has cost of $ 50,000 and accumulated depreciation of $ 20,000. The owner agrees to exchange with another car. We do not have any market value of both assets. Management estimate there is no commercial substance related to this transaction.
As both assets do not have fair value, there is no commercial substance related to the transaction. So the new assets value equal to the transferred asset.
The journal entry will debit cost of new car and accumulated depreciation of old car, the credit side is the cost of old car.
| Account | Debit | Credit |
|---|---|---|
| Cost _ New Car | 30,000 | |
| Acc.Dep _ Old Car | 20,000 | |
| Cost _ Old Car | 50,000 |