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Santos Corporation had the following two exchanges of property, plant, and equipment during 2023: Assets Given Assets Received a. Land Cost $1,000,000 Land Fair Value $1,000,000 Fair value $1,000,000 Building Cost $4,800,000 Building Fair Value $3,000,000 Accumulated depreciation $2,160,000 Fair value $3,000,000 Transaction a lacks commercial substance. b. Equipment Cost $540,000 Land Fair Value $520,000 Accumulated depreciation $460,000 Fair value ? Cash $340,000 Transaction b has commercial substance. Requirement: Prepare the journal entries to record the two exchanges.

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Example Transaction has Commercial Substance Asset(s) Given Asset(s) Received 1. Equipment 1. Equipment Cost $20,000 Fair value $15,000 Accum. depreciation 6,500 Book value $13,500 2. Cash $1,000 The equipment received has the most readily determinable market value. The fair value of the asset given in exchange is assumed to be $14,000. ($15,000 fair value of asset received - $1,000 cash paid)

Nonmonetary Exchange

Example Transaction has Commercial Substance Journal Entry to record exchange: Equipment 15,000 Accumulated depreciation, equipment 6.500 Equipment 20,000 Cash 1,000 Gain on exchange of assets 500 The gain is the excess of the fair value of the asset given ($14,000) over its book value ($13,500).

Nonmonetary Exchange

No Commercial Substance Determining whether a transaction has commercial substance requires professional judgment. Two indications that a transaction is likely to have commercial substance are: 1. The amount of cash exchanged is significant in relation to the fair value of the assets exchanged. 2. The functions of the assets exchanged are different. For example, if land is exchanged for equipment, the timing of the cash flows from the assets are likely to be different. Nonmonetary Exchange

No Commercial Substance When a nonmonetary exchange lacks commercial substance, the asset acquired is recorded at the book value of the assets given in exchange with the following exceptions: If a loss is evident, it is recognized in full and the acquired asset is recorded at market value. When a gain is evident and cash is received, the gain is recognized in proportion to the amount of cash received, and the acquired asset is recorded at market value less the portion of the gain that is not recognized. If the proportion of the cash is 25% or more, the entire gain is recognized, and the acquired asset is recorded at market value.

Nonmonetary Exchange Example 1 No Commercial Substance Asset(s) Given Asset(s) Received 1. Equipment 1. Equipment Cost $20,000 Fair value $15,000 Accum. depreciation 6,500 Book value $13,500 2. Cash $1,000 Asset given is assumed to be worth $14,000 ($15,000 - $1000). Unrecognized gain of $500 ($14,000 - $13,500). Gain is not recognized because transaction lacks commercial substance and no cash is received. Nonmonetary Exchange 42

Example 1 No Commercial Substance Journal Entry to record exchange: Equipment 14,500 Accumulated depreciation, equipment 6.500 Equipment 20,000 Cash 1,000 Because the gain isnt recognized, the new asset is recorded at the book value of the assets given in exchange. Nonmonetary Exchange 43

Example 2 No Commercial Substance Asset(s) Given Asset(s) Received 1. Equipment 1. Equipment Cost $20,000 Fair value $15,000 Accum. depreciation 6,000 Book value $14,000 2. Cash $3,000 Asset given is assumed to be worth $12,000 ($15,000 - $3,000). Implied loss of $2,000 ($14,000 book value - $12,000 value). Losses are recognized, even if the transaction lacks commercial substance. Nonmonetary Exchange 44

Example 2 No Commercial Substance Journal Entry to record exchange: Equipment 15,000 Accumulated depreciation, equipment 6,000 Loss on exchange of equipment 2,000 Equipment 20,000 Cash 3,000 Losses on nonmonetary exchanges are always recognized in full. The new asset is recorded at its fair value. Nonmonetary Exchange 45

Example 3 No Commercial Substance Asset(s) Given Asset(s) Received 1. Equipment 1. Equipment Cost $20,000 Fair value $10,000 Accum. depreciation 6,000 Book value $14,000 2. Cash 1,500 Asset given is assumed to be worth $11,500 ($10,000 + $1,500). Implied loss of $2,500 ($14,000 book value - $11,500 value). Losses are recognized, even if the transaction lacks commercial substance. Nonmonetary Exchange 46Example 3 No Commercial Substance Asset(s) Given Asset(s) Received 1. Equipment 1. Equipment Cost $20,000 Fair value $10,000 Accum. depreciation 6,000 Book value $14,000 2. Cash 1,500 Asset given is assumed to be worth $11,500 ($10,000 + $1,500). Implied loss of $2,500 ($14,000 book value - $11,500 value). Losses are recognized, even if the transaction lacks commercial substance. Nonmonetary Exchange 46

Example 3 No Commercial Substance Journal Entry to record exchange: Equipment 10,000 Accumulated depreciation, equipment 6,000 Cash 1,500 Loss on exchange of equipment 2,500 Equipment 20,000 Losses on nonmonetary exchanges are always recognized in full. The new asset is recorded at its fair value. Nonmonetary Exchange 47

Example 4 No Commercial Substance Asset(s) Given Asset(s) Received 1. Equipment 1. Equipment Cost $20,000 Fair value $10,000 Accum. depreciation 15,000 Book value $ 5,000 2. Cash 1,500 Asset given is assumed to be worth $11,500 ($10,000 + $1,500). Implied gain of $6,500 ($11,500 fair value - $5,000 book value). Cash represents $1500 / ($10,000+$1,500) or 13% of the value of the consideration received. So 13% of the gain will be recognized. (13% of the asset was sold for cash; the rest was exchanged. (13% of $6,500 = $845) Nonmonetary Exchange 48Example 4 No Commercial Substance Asset(s) Given Asset(s) Received 1. Equipment 1. Equipment Cost $20,000 Fair value $10,000 Accum. depreciation 15,000 Book value $ 5,000 2. Cash 1,500 Asset given is assumed to be worth $11,500 ($10,000 + $1,500). Implied gain of $6,500 ($11,500 fair value - $5,000 book value). Cash represents $1500 / ($10,000+$1,500) or 13% of the value of the consideration received. So 13% of the gain will be recognized. (13% of the asset was sold for cash; the rest was exchanged. (13% of $6,500 = $845) Nonmonetary Exchange 48

Example 4 No Commercial Substance Journal Entry to record exchange: Equipment 4,345 Accumulated depreciation, equipment 15,000 Cash 1,500 Gain on exchange of equipment 845 Equipment 20,000 The new asset is recorded at its fair value of $10,000 reduced by the unrecognized gain of $5,655 ($6500 - $845) . Nonmonetary Exchange 49

Example 5 No Commercial Substance Asset(s) Given Asset(s) Received 1. Equipment 1. Equipment Cost $20,000 Fair value $10,000 Accum. depreciation 15,000 Book value $ 5,000 2. Cash 5,000 Asset given is assumed to be worth $15,000 ($10,000 + $5,000). Implied gain of $10,000 ($15,000 fair value - $5,000 book value). Cash represents $5,000 / ($10,000+$5,000) or 33% of the value of the consideration received. Since more than 25% of the consideration is cash, the entire gain is recognized and the asset is recorded at its fair value. Nonmonetary Exchange 50

Example 5 No Commercial Substance Journal Entry to record exchange: Equipment 10,000 Accumulated depreciation, equipment 15,000 Cash 5,000 Gain on exchange of equipment 10,000 Equipment 20,000 The gain is recognized in full; the new asset is recorded at its fair value. Nonmonetary Exchange 51

If fair values of assets cannot be determined, no gain or loss is recognized. The acquired asset is recorded at the book value of the old asset + cash paid or cash received. Losses are recognized in full and the acquired assets are recorded at their fair value. [Loss = book value fair value of asset given in exchange.] Nonmonetary Exchanges Summarized 52

If the fair value of the asset given in the exchange exceeds its book value, a gain is evident. If the transaction has commercial substance, recognize the entire gain and record the acquired asset at its fair value. If there is no commercial substance and cash is not received in the exchange, no gain is recognized and the newly acquired asset is recorded at the book value of the asset given + cash paid. If there is not commercial substance and cash is received in the exchange, recognize the gain in proportion to the cash received and record the new asset at its fair value minus the unrecognized gain. Exception: If the proportion of cash received is 25% or more of the value of the transaction, recognize the entire gain and record the acquired asset at its fair value. Nonmonetary Exchanges Summarized 53

Costs that will provide long-term benefits (over one year), if material in amount. The cost must do one of the following: Improve functionality Extend the useful life Costs Capitalized During Life of Asset 54

Costs that maintain the asset at its normal productivity throughout its expected useful life are not capitalized, but expensed on the income statement when incurred (repairs and maintenance expense). Costs Capitalized During Life of Asset 55 Costs that maintain the asset at its normal productivity throughout its expected useful life are not capitalized, but expensed on the income statement when incurred (repairs and maintenance expense). Costs Capitalized During Life of Asset 55

Additions New major component of an asset that did not exist before, such as the addition of a wing to a building. If an integral part of the larger asset, depreciate the addition over the shorter of its useful life or the remaining useful life of the larger asset. (Installation of central air heating/cooling system) If not an integral part, depreciate over additions useful life. Costs Capitalized During Life of Asset 56

Improvements or Betterments Replacement of a major asset component with one better than the original (replacing a shingled roof with a tiled one) If the accounting system maintains records of the old component cost and accumulated depreciation, remove the old component from the records and record the loss. Capitalize the cost of the improvement as part of the larger asset. If the old component cost is not known and the productivity of the larger asset is enhanced, increase the larger asset account by the cost of the improvement. Depreciate over the shorter of the improvements useful life or the remaining useful life of the larger asset. Costs Capitalized During Life of Asset 57Improvements or Betterments Replacement of a major asset component with one better than the original (replacing a shingled roof with a tiled one) If the accounting system maintains records of the old component cost and accumulated depreciation, remove the old component from the records and record the loss. Capitalize the cost of the improvement as part of the larger asset. If the old component cost is not known and the productivity of the larger asset is enhanced, increase the larger asset account by the cost of the improvement. Depreciate over the shorter of the improvements useful life or the remaining useful life of the larger asset. Costs Capitalized During Life of Asset

Extraordinary Repairs Large expenditures that increase the useful life of the larger asset but do not enhance productivity. Debit accumulated depreciation for the cost of the repair or improvement. This method of accounting maintains the cost at the original amount, but increases the remaining book value, extending the useful life. Costs Capitalized During Life of Asset

Rearrangement Restructuring an asset to create a benefit. (cost of relocating the plant facilities to another city) Capitalize the rearrangement/restructuring costs. Costs Capitalized During Life of Asset

I also did this Question Here is instructor feedback !! Look at them !!

You state in your answer that "In this exchange, the fair value of the land given and received is the same, so it lacks commercial substance." This is not why it lacks commercial substance, It is because the projected cash flows from the new land and building are essentially the same as from the ones given up. The relative fair values are not the determining factor.

In part "a", you are correct in stating that no gain or loss is recognized because the transaction lacks commercial substance. But notice that this transaction is not only an exchange of land. Land with a building on it was exchanged for another parcel of land with a building. You need to account for the building portion as well as the land.

Your analysis of the transaction as it affects land is correct, except you don't need to make an entry to land since you are increasing and decreasing the account by the same amount. You will need to make an entry to record the building portion of the exchange.

You included the building with the entry for transaction "b" where equipment was given up. There are two exchanges in this problem. In the first exchange, land and a building are exchanged for another parcel of land with a building. The exchange lacks commercial substance. In the second exchange, land is acquired in exchange for equipment and cash. The second transaction has commercial substance, because the expected cash flows from the land are different than those from the equipment and cash.

Your entries will change once you've included the building in transaction "a". However, I did take a look at your computation of the carrying amount of the equipment and the gain recognized on its exchange. You correctly computed the carrying amount as $80,000. However, when nonmonetary assets are exchanged, the gain or loss is the difference between the fair value and the carrying value of the asset given up. The amount of cash exchanged does not affect the gain or loss.