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Can anyone explain to me why the second question implies that the 25% rule applies to boot paid, when the first question states the opposite? My book says that the 25% rule only applies to boot received. Thanks!
Campbell Corp. exchanged delivery trucks with Highway Inc. Campbell’s truck originally cost $23,000, its accumulated depreciation was $20,000, and its fair value was $5,000. Highway’s truck originally cost $23,500, its accumulated depreciation was $19,900, and its fair value was $5,700. Campbell also paid Highway $700 in cash as part of the transaction. The transaction lacks commercial substance. What amount is the new book value for the truck Campbell received?
a.
$3,000
b.
$3,700
c.
$5,700
d.
$5,000
Explanation
Choice “b” is correct. The gain or loss is calculated by subtracting the net book value of the asset surrendered from its fair value. The fair value of the asset surrendered must always equals the fair value of the asset received, even if only one of these amounts is given. In this fact pattern, the net book value of Campbell’s truck is $3,000 ($23,000 − $20,000) and its fair value is $5,000, so there is a gain of $2,000.
However, because this exchange lacks commercial substance, Campbell will only recognize a gain if it received boot/cash. If boot/cash is given, or there is no boot/cash in the transaction, then no gain is recognized. Because Campbell pays cash of $700, not gain is recognized. Therefore, the journal entry to record the transaction and “plug” for the book value of the Truck received by Campbell is:
Debit (Dr)
Credit (Cr)
New truck $ 3,700*
Accumulated depreciation 20,000
Old truck $ 23,000
Cash 700
On January 2, Elbert’s Delivery Company and Wanda’s Exporters exchanged similar delivery trucks in an exchange that lacks commercial substance. Data relative to the trucks follow:
Elbert’s truck
Original cost
$10,000
Accumulated depreciation as of January 2
8,000
Fair market value
3,000
Wanda’s truck
Book value
$15,000
In the exchange, Elbert paid Wanda cash of $10,000. Elbert’s Delivery Company should record the new truck at:
a.
$10,000
b.
$13,000
c.
$8,000
d.
$12,000
Explanation
Choice “b” is correct. The new truck is recorded at $13,000 on Elbert’s books. In this case, the transaction is considered to be a monetary exchange, because the boot ($10,000) exceeds 25% of the total consideration ($10,000 plus $3,000 fair value of the old truck transferred to Wanda). Therefore, both parties to the exchange recognize all gains and losses on the transaction. The journal entry prepared by Elbert follows:
Debit (Dr)
Credit (Cr)
Truck-New $ 13,000
Accum. Depre. 8,000
Cash $ 10,000
Truck-Old 10,000
Gain 1,000
Choice “d” is incorrect. This is an exchange where the boot is greater than 25% of the total consideration. The boot is $10,000 and the total consideration is $13,000 (boot plus $3,000 fair value of Elbert’s old truck.) Therefore, all gains and losses are recognized by both parties to the transaction. The gain to Elbert is $1,000, or the difference between the fair value of the truck of $3,000 and the carrying value of $2,000. The gain must be recognized, leading to a recorded cost of Elbert’s new truck of $13,000. The rule states that when the boot exceeds 25% of the total consideration, the transaction is considered to be monetary.
Option “a” is incorrect. $10,000 is the original cost of the old truck to Elbert.
Option “c” is incorrect. $8,000 is the total amount of accumulated depreciation at the time of the asset exchange.
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