Question

Cheyenne Company exchanged equipment used in its manufacturing operations plus $3,480 in cash for similar equipment used in the operations of Ayayai Company. The following information pertains to the exchange.

		CheyenneCo.			Ayayai Co.
Equipment (cost)		$32,480			$32,480
Accumulated depreciation		22,040			11,600
Fair value of equipment		14,500			17,980
Cash given up		3,480

1.    Prepare the journal entries to record the exchange on the books of both companies. Assume that the exchange lacks commercial substance.

2.    Prepare the journal entries to record the exchange on the books of both companies. Assume that the exchange has commercial substance.

Answer 1

1. Journal entries if lacks commercial substance:

(i) In the books of Cheyenne Co.:

Account Title and Explanation	Debit	Credit
Equipment (new) (17,980 - 3,402)	14,578
Accumulated Depreciation-Equipment	22,040
Equipment		32,480
Gain on Disposal of Equipment		658
Cash		3,480
[Equipment exchanged for another equipment and cash]

Calculations:

Verification of % of cash received whether it is more than 25% of fair value of the equipment exchanged or not:

(i) 25% of the fair value of the equipment exchanged = 14,500 x 25% = 3,625

(ii) Cash paid = 3,480

Cash paid is less than the 25% of the fair value of the equipment given, Therefore, Partial gain should be recognized.

Calculation of Total Gain:

Fair value of Equipment exchanged	14,500
Less: book value of machine exchanged (32,480-22,040)	-10,440
Total gain	4,060

Recognized gain = [Cash Received /(Cash received + Fair value of Other Asset Received)] x Total gain

= 3480/(3480+17980) x 4060

= $658

Calculation of Deferred gain:

Total Gain	4,060
Less: Gain recognized	-658
Deferred gain	3,402

Note: Cost of equipment received is reduced by Deferred gain.

(ii) In the books of Ayayai. Co.:

Account Title and Explanation	Debit	Credit
Cash	3,480
Equipment (new)	14,500
Accumulated depreciation	11,600
Loss on Disposal of Equipment	2,900
Equipment		32,480

Calculations:

Fair value of Equipment exchanged	17,980
Less: book value of machine exchanged (32,480-11,600)	-20,880
Total Loss	-2,900

*Loss should be recognized immediately whether it has commercial substance or lack of commercial substance.

2. Journal entries if transaction has a commercial substance:

In the books of Cheyenne Co.:

Account Title and Explanation	Debit	Credit
Equipment (new)	17,980
Accumulated Depreciation-Equipment	22,040
Equipment		32,480
Cash		3,480
Gain on Disposal of Equipment		4,060

In the books of Ayayai Co.:

Account Title and Explanation	Debit	Credit
Cash	3,480
Equipment (new)	14,500
Accumulated depreciation	11,600
Loss on Disposal of Equipment	2,900
Equipment		32,480