Question

(Nonmonetary Exchange) Carlos Arruza Company exchanged equipment used in its manufacturing operations plus \(3,000 in cash for similar equipment used in the operations of Tony LoBianco Company. The following information pertains to the exchange.

	Carlos Arruza Co.	Tony LoBianco Co.
Equipment (cost)	\)28,000	$28,000
Accumulated depreciation	19,000	10,000
Fair value of equipment	12,500	15,500
Cash given up	3,000

Instructions

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.

Short answer

		Carlos Arruza	Tony Lo Bianco
(a)	Accumulated depreciation	$19,000	$10,000
(b)	Equipment cost	$15,500	$12,500

Step-by-step solution

Meaning of Commercial Substance

When a business's future cash flow changes due to a business entity's transaction, a commercial substance exists in that transaction

(a) Preparing journal entries

Exchange lacks commercial substance.

Carlos Arruza Company:

Date	Particular	Debit ($)	Credit ($)
	Equipment	12,000
	Accumulated Depreciation-Equipment	19,000
	Equipment		28,000
	Cash		3,000

Working notes:

Calculating Valuation of equipment

Book value of equipment given up	$ 9,000
Add: Cash paid	3,000
New equipment	$12,000

Calculation of gain on disposal

The fair value of old equipment	$12,500
Less: Book value of old equipment	9,000
Gain on disposal	$ 3,500

Note: The gain is delayed since the cash paid is less than 25% of the entire amount given up, and the transaction is nonmonetary.

Tony Lo Bianco Company:

Date	Particular	Debit ($)	Credit ($)
	Cash	3,000
	Equipment	12,500
	Accumulated Depreciation-Equipment	10,000
	Loss on Disposal of Equipment	2,500
	Equipment		28,000

Calculation of Loss on disposal of equipment

Computation of loss
Book value of old equipment	$18,000
Less: Fair value of old equipment	15,500
Loss on disposal of equipment	$ 2,500

(b) Preparing journal entries

The exchange has commercial substance

Carlos Arruza Company

Date	Particular	Debit ($)	Credit ($)
	Equipment	15,500
	Accumulated Depreciation-Equipment	19,000
	Equipment		28,000
	Cash		3,000
	Gain on Disposal of Equipment		3,500

Calculation of Cost of new equipment

Cost of new equipment
Cash paid	$3,000
The fair value of old equipment	12,500
Cost of new equipment	$15,500

Computation of gain on disposal of equipment:

The fair value of old equipment	$12,500
Less: Book value of old equipment($28,000-$19,000)	9,000
Gain on disposal of equipment	$ 3,500

Tony LoBianco Company

Date	Particular	Debit ($)	Credit ($)
	Cash	3,000
	Equipment	12,500
	Accumulated Depreciation-Equipment (Old)	10,000
	Loss on Disposal of Equipment	2,500
	Equipment		28,000

Working notes:

Calculation of Cost of new equipment

The fair value of equipment	$15,500
Less: Cash received	3,000
Cost of new equipment	$12,500

Computation of loss on disposal of equipment

Book value of old equipment ($28,000-$10,000)	$18,000
Less: Fair value of the equipment (Old)	15,500
Loss on disposal of equipment	$ 2,500