Question

Karim Company exchanged equipment used in its manufacturing operations plus SAR6,000 in cash for similar equipment used in the operations of Mansour Company. The following information pertains to the exchange.

                                                                            Karim Co           Mansour Co

                        Equipment (cost)                           84,000                 84,000

                         Accumulated depreciation           57,000                 30,000

                        Fair value of equipment                40,500                 46,500

                        Cash given up                                 6,000    

Instructions

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

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

Answer 1

(a) Journal Entries to record the exchange on the books of both companies assuming the exchange lacks commercial substance

Karim Co. must recognize the transaction using the following journal entry

Mansour Co. Equipment (b/f) Dr	33,000
Accumulated depreciation Dr	57,000
To Karim Co. Equipment		84,000
To Cash		6,000

Mansour Co. must recognize the transaction using the following journal entry

Cash Dr	6,000
Karim Co. Equipment (b/f) Dr	47,032.25
Accumulated depreciation Dr	30,000
Profit & Loss Dr	967.75
To Mansour Co. Equipment		84,000

Since the fair value of the Mansour Co. Equipment is lower than its book value by $7,500 (i.e. fair value of $46,500 minus book value of tower of $54,000 (=$84,000 - $30,000)), Mansour Co. can recognize only such loss on exchange which is realized in cash i.e. $967.75 (=$6,000/$46,500 × $7,500).

(b) Journal Entries to record exchange on the books of both companies assuming that exchange has commercial substance

Karim Co. must recognize the transaction using the following journal entry

Mansour Co. Equipment Dr	46,500
Accumulated Equipment Dr	57,000
To Karim Co. Equipment		84,000
To Cash		6,000
To Profit & Loss		13,500

Mansour Co. must recognize the transaction using the following journal entry

Karim Co. Equipment Dr	40,500
Accumulated Depreciation Dr	30,000
Cash Dr	6,000
Profit & Loss Dr	7,500
To Mansour Co. Equipment		84,000