[jessanqi]

I’m confused with the below question, according to Wiley textbook, no gain is recognized on an involuntary conversion if the amount reinvested in replacement property equals or exceeds the amount realized form the converted property. why not the answer is $0.

Can someone please kindly advise.

Thank you in advance!!!

On June 30, 20X5, a fire in Ruffing Company’s plant caused a total loss to a production machine. The machine had a book value of $80,000 at December 31, 20X4, and was being depreciated at an annual rate of $10,000. The machine had a fair value of $110,000 at the date of the fire, and Ruffing received insurance proceeds of $100,000 in October 20X5. The same month Ruffing purchased a replacement machine for $130,000. Ignoring income taxes, what amount should Ruffing report on its 20X5 income statement as involuntary conversion gain or loss?

A. $0
B. $10,000 loss.
C. $20,000 gain.
D. $25,000 gain.

Explanation
The correct answer is D. For financial reporting purposes, a gain or loss on an involuntary conversion would be determined based on the book value of the asset on the date of the loss and the amount received as an insurance reimbursement. The fact that a lost asset is replaced has no bearing on the outcome for accounting purposes although it has important meaning for tax purposes.

The key in this question is to recognize that the accumulated depreciation must be updated to the date of the loss. In this case, we are given that the book value of $80,000 is through December 31, 20X4. Therefore, since the machine is being depreciated at the rate of $10,000 per year, we must record an additional one-half year’s depreciation. This results in the machine having a book value of $75,000 ($80,000 – $5,000 additional depreciation thru June 30, 20X5) at the date of the loss. Since Ruffing received insurance proceeds of $100,000 it will have a $25,000 gain on the involuntary conversion.

[Missy]

I think it's this part of the solution that answers your question:

. The fact that a lost asset is replaced has no bearing on the outcome for accounting purposes although it has important meaning for tax purposes.

Old timer,  A71'er since 2010.

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Licensed Massachusetts Non Reporting CPA since 2012
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