[TheAccountant]

2. (Lack of Commercial Substance) A plant asset (cost $40,000; accumulated depreciation $13,000) is exchanged for another plant asset with a fair value of $30,000. Cash of $2,000 is also paid to even the exchange. The exchange is determined to lack commercial substance. (Same data as previous example.)

Journal entry for the exchange:

Plant asset 29,000

Accumulated depreciation 13,000

Plant asset 40,000

Cash 2,000

Can someone please explain to me why there is no loss recorded? There is boot involved and there is no commercial substance so shouldn’t the plant asset received be valued at 30k and record a loss of 1k?

[tuanxn]

Here's the way I see it. If anything, there should be a gain of $1000 deferred in the transaction.

The carrying value of the original plant asset is $27,000 (cost of $40,000 – accumulated depreciation of $13,000)
The FMV of the original plant asset is $28,000. So if we sold the original plant asset, we would recognize a gain of $1,000.

Instead, we trade the original plant asset for a new plant asset worth $30,000. Since the new plant's FMV is $2,000 more than our old plant's FMV, we throw in $2,000 cash to make the transaction lack commercial substance.

Since we PAID the boot, we do not recognize gain at this time.

This forces us to record the new plant on our books at $29,000 so that if we turn around and sell it for its FMV of $30,000; we will recognize $1,000 of gain that we would have recognized on our original plant asset.

If you simply remove the old plant asset account ($40,000 credit), it's accumulated depreciation ($13,000 debit), and the boot ($2,000 credit); you'll realize that you need to record the new plant asset at ($29,000 debit) to simply make the journal entry balance.

[Author]

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