9.3.5: Non-monetary Exchanges

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When PPE assets are acquired through payments other than cash, the question that arises is how to value the transaction. Two particular types of transactions can occur: 1) a company can acquire a PPE asset by issuing its own shares, or 2) a company can acquire a PPE asset by exchanging it with another asset the company currently owns.

Asset Acquired by Issuing Shares

When a company issues its own shares to acquire an asset, the transaction should be recorded at the fair value of the asset acquired. IFRS presumes that this fair value should normally be obtainable. This makes sense, as it unlikely that a company would acquire an asset without having a reasonable estimate of its value. If the fair value of the asset acquired is not determinable, then the asset should be reported at the fair value of the shares given up. This value is relatively easy to determine for an actively traded public company. In cases where neither the value of the asset nor the value of the shares can be reliably determined, the asset could not be recorded.

Asset Acquired in Exchange for Other Assets

When assets are acquired though exchange with other non-monetary assets or a combination of monetary and non-monetary assets, the asset acquired should be valued at the fair value of the assets given up. If this value cannot be reliably determined, then the fair value of the asset received should be used. Notice how this differs from the rule for share-based payments. The presumption is that the fair values of assets are generally more reliable than the fair values of shares.

The implication of this general rule is that when non-monetary assets are exchanged, there will likely be a gain or loss recorded on the transaction, as fair values and carrying values are usually not the same. The recognition of a gain or loss suggests that the earnings process is complete for this asset. This seems reasonable, as each company involved in the transaction would normally expect to receive some economic benefit from the exchange.

There are two instances, however, where the general rule does not apply. These two situations occur when:

The fair values of both assets are not reliably measurable.
The transaction lacks commercial substance.

Although it is an unusual situation, it is possible that the fair value of neither asset can be reliably determined. In this case, the asset acquired would be recorded at the book value of the asset given up. This means that no gain or loss would be recorded on the transaction.

A more likely situation occurs when the transaction lacks commercial substance. This means that after the exchange of the assets, the company's economic position has not been altered significantly. This condition can usually be determined by considering the future cash flows resulting from the exchange. If the business is not expected to realize any difference in the amount, timing, or risk of future cash flows, either directly or indirectly, then there is no real change in its economic position. In this case, it would be unreasonable to recognize a gain, as there has been no completion of the earnings process. This type of situation could occur, for example, when two companies want to change their strategic directions, so they swap similar assets that may be located in different markets. There may be no significant difference in cash flows, but the assets received by each company are more suitable to their long-term plans. In this case, the asset acquired is reported at the carrying value of the asset given up.

One instance where accountants need to be careful occurs when an asset exchange lacks commercial substance and the carrying amount of the asset given up is greater than the fair value of the asset acquired. If we apply the principle for non-commercial exchanges by recording the asset acquired at the carrying value of the asset given up, the result will be an asset reported at an amount greater than its fair value. This result would create a misleading statement of financial position, so in this case, the asset acquired should be reported at its fair value, even though there is no commercial substance. This will result in a loss on the exchange.

Consider the following illustrations of asset exchanges.

Commercial Substance

ComLink Ltd. decides to change its manufacturing process in order to accommodate a new product that will be introduced next year. They have decided to trade a factory machine that is no longer used in their production for a new machine that will be used to make the new product. The machine that is being disposed of had an original cost of $78,000 and accumulated depreciation of $60,000. The fair value of the old machine at the time of exchange was $22,000. The new machine being obtained has a list price of $61,000. After a period of negotiation, the seller finally agreed to sell the new machine to ComLink Ltd. for cash of $33,000 plus the trade-in of the old machine. As the new machine will be used to manufacture a new product for the company, and the old machine was essentially obsolete, we can reasonably conclude that this transaction has commercial substance. In this case, the journal entry to record the exchange will be:

Note that the new machine is reported at the fair value of the assets given up in the exchange (). Also note that the gain on the disposal is equal to the fair value of the old machine ($22,000) less the carrying value of the machine at disposal ().

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No Commercial Substance

Assume that ComLink Ltd. has a delivery truck that it purchased one year ago for $32,000. Depreciation of $5,000 has been recorded to date on this asset. The company decides to trade this for a new delivery truck in a different colour. The new truck has the same functionality and expected life as the old truck. The only difference is the colour, which the company feels ties in better with its corporate branding efforts. No identifiable cash flows can be associated with the effect of this branding. The fair value of the old truck at the time of the trade was $28,000. The seller of the new truck agrees to take the old truck in trade, but requires ComLink Ltd. to pay an additional $5,000 in cash. In this instance, because there is no discernible effect on future cash flows, we would reasonably conclude that the transaction lacks commercial substance. The journal entry to record this transaction would be:

Note that the new truck is reported at the book value of the assets given up (). Also note that the implied fair value of the new truck () is not reported, and no gain on the transaction is realized.

If the same exchange occurred, but we were able to ascertain that the fair value of the asset acquired was only $30,000, it would be inappropriate to record the new asset at a value of $32,000, as this would exceed the fair value. The journal entry would thus be:

Note that the new truck is recorded at the lesser of its fair value and the book value of the asset given up. This results in a loss on the transaction, even though the transaction lacks commercial substance.

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