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A clarification of certain issues arising out of nonmonetary exchanges
TcwSng and Educational Note
Abs~ac~ Accounting for certain nonmonetary exchwrnges has fang been n~.&t~d by ccmfu&n and controversy. The wording of Accounting Frirlciples Board Opinic)* No. 29 (APB0 29) is especially ambiguous as to when an earnings procpss is culminated, and therefore as to when n iransaetion is rec&ed a* market ur a?nek dws. SWcm&tg academic a& pedagogic &etafnz Aas seized aa &e d~ss~rn~~~t~& @KC as~bs ex&aaged as being mxess~ and sufficient tct retarding at fair x&es. Thftisz-$x%~e, un~~~~na~~~~~fa%s to capSure I& ecn%?mic SUbsrmW%of the transa~~~~n* This has been pointed auf by FIabbs and Bainbr~~~~ (E982) and fwtb.” clarified by the Emerging Issuer Task Force (Ef’TP) of the Financial. Accounting Standards Board @‘A!%) (1986). The purpose of this paper is; to bring the proper treatment of such transactions la rbe attention of ficccounting educators SDthat the pedagogic literature may be ap~~~~~~~~ adjust&.
INTRODUCTION AND OVERVIEW OF THE PRIC”rHtEM “We 02?serveac&Quntatnts’ actkms tu discover what to teach, then we teach tlwl Ixm to- act, tlB% we observe a~~o~tan~~ aems EC3disQver what to teach If This commentby Sterling qr9-m) effectively ~~~~~~ L
_
-
the dynN&s of current confusion over accounting for exchanges of nc)Wtmonetary assets. Wide variation in practice regarding the valuation of assets transferred in nonmonetary exchanges and the recognition of gains or losses cm swh bzmztctions, pxmpted the issuance of Accounting Princig&s Board Qpinion fA33.3~) No= 29 fH73). ~nbse~ne~~ ~~te~re~t~o~s af Opmiorr 53 and observ&on of practice h&s failed to produce a ~on~~~~~~ understandable method of capturing the economic substance of certain nonmonetary exchanges, In a frequently cited paper on the topic, Capettlni and King (1976, p. 142) noted early difficulties observing that: “ . . . sumo parts of &e Opinion C&s&w w&b ~~~~~~~~a~ exchmgkxi are quite difficult to interpret* and ewzn the new ewons of ~~~~~~~~~~~ acmrmting text9 . - - f&iito present an ~d~~~ate exp~anat~~~. _ _ . ” In Capertini and King”s (19%) view, exchanges of similar productive assets are to be accounted for at recorded values. The approach results irk deferral of gain in trade-in type transwtions involving similar productive
366
D. Marcinko and E. Petri
assets.’ This represents a broad interpretation of Paragraph 3 of Opinion 29 which defines GmiIar prod~~ve assets as being: a) of the sme genera% type, b) p~f~~~ng the same function, or c) used in the same fine of business. Thus, the same type at’ asset used in djfferent lines of business to perform different functions would still be treated as similar since it would qualify under item (a). Our review of the current textbook literature found that this treatment dominates the discussion of trade-in transections. In those texts where trade-ins are not expiicit@ covered, s~rn~~~~t~of the assets is viewed as a sufficient condition to account for an exchange by using recorded rather than fair vaiueXjl. Hobbs and B&bridge (1982) challenged the Capettini and Ming (1976) interpretation of what type of transaction culminated the earnings process. Direct comrn~~c~t~on with three Board members by Hobbs and Bambridge reveafed that the rnod~f~cat~o~ to the basic pr~~c~p~eapp%s on& when the relationship between the transacting parties is symmetrical, Le,, two dealers or two nondealers in the assets exchanged. They quote the foIlowing passage from the response to their inquiry:
In a trade-in transaction3 the earnings process is culminated for the dealer. The Hobbs and Bainbridge (1982) disclosure makes it clear that in such a &nation the basic principle must be used by the nondealer as wefl as the de&er, Restated, this new information ~~a~~~s~~ that tke ~u~rn~nat~o~ of the earnings process and thus use of the b&c principle occurs in either of the following situations: 1, When the relationship between the parties Is asymmetrical, or 2. When the ~~oductjve assets exchanged are dissimUar. More recently, FASB Emerging Issues Task Force Issues ~~mrna~ 863~ (1986) has moved in the same direction taken by Hobbs and Bainbridge (1982). Prompted by an expreg8sd need to narr~~w practice, the Emerging Issues Task Force (EITF) reached consensus on several questions regarding ~o~rnonet~y exchanges, including whether aa enterprise should record a fixed asset ac4uired in exchange for another fixed asset at the cust of the fixed asset transferred or at fair vahre. Trade& transactions fail into this category. In considering the question, the Task Force has narrowed the
Nonmonetary Exchanges
367
meaning of the phrase “similar productive asset” to focus on whether or not the productive assets exchanged are used in the “same line of business.” As stated, paragraph 3 of Opinion 29 (1982) broadly defined similar productive assets as those which satisfy any one of the three following conditions: 1. Assets that are of the same general type; 2. Assets performing the same function; 3. Assets employed in the same line of business. Issue Summary 86-29 (1986, pp. 6-7) sets forth two necessary conditions: The modification of the basic principle may be used if and only if the fixed assets exchanged are similar and are employed in the same line of business. This has led to the adoption of a “same line of business” test that requires recording at book values (modification of the basic principle) if the exchange involves similar fixed assets used in the same line of business. In the absence of either of these two conditions, fair market value is used. The EITF has sharpened the criteria presented in Hobbs and Bainbridge (1982). No longer is it necessary to speculate as to what is meant by a symmetric relationship between trading parties. Once the parties establish that similar productive assets used in the same line of business are being exchanged, the proper accounting treatment for the transaction is determined. The authoritative nature of Issue Summary 86-29 (1986) requires that these new criteria be adopted by the authors of financial accounting texts in order to promote wider dissemination and the narrowing of practice desired by the EITF. The same Issue Summary also has addressed the question of how much boot may be involved for the transaction to be considered nonmonetary (1986, pp. 10-13). It establishes a threshold of 25% of the total fair value exchanged for determining when boot is significant. If the amount of boot exceeds this 25% threshold, the exchange is monetary and must be recorded at fair value by both the recipient and payer of boot. This decision, therefore, needs to be incorporated into the text literature to reduce confusion. The EITF Issue Summary (1986) finally produces a workable set of criteria for deciding between the basic principle and its modification. For the paragraph 21 exception to the basic principle to apply, all of the following conditions must be satisfied by the party concerned: The assets exchanged must be similar and used in the same line of business by both parties to the exchange; there must not be a loss on the exchange; and, the amount of boot involved (if any) must be less than 25% of the total fair value exchanged.2 *A given transaction satisfying these conditions may involve a loss for one party and a gain for the other. Under these conditions, Issue Summary 86-29 (1986) implies that the party that has incurred the loss will record at market values, while the party realizing a gain will apply the paragraph 21 exception.
D. Marcinko and E. Petri
368
THE DIFFERENCE BETWEEN THE CAPETTINf AND KING AND HOBBS AND ~A~~B~~D~E~E~TF T~AT~~E~ In order to illustrate the treatment of a trade-in consistent with the EITF Issue Summary (1986) and Hobbs and Bainbridge (1982), assume the following facts concerning a particular transaction. PMD Corporation, a manufacturer of quality furniture, trades in its old delivery vehicle and pays $5,000 cash to Deafer Corporation for a new delivery vehicle. The old delivery vehicle’s a~~~is~t~~~ ectst to PMD Corporation was $30,000, and depreciation of $18,000 had accumulated up to the date of the exchange. A trade-in allowance of $18,500 is negotiated with DeaIer Corporation. The fair market value of this vehicle is $16,000. Dealer Corporation was asking $23,500 for the new vehicle which has an invoice cost of $f8,600. The entries in Table 1 compare the Capettini and King and the Hobbs and Bainbridge/EITF methods of recording the transaction for both companics . Based on the conclusion that the exchange of physically similar productive assets does not culminate the earnings process, Capettini and King apply the modification of the basic principle to the PMD Corparation- The asset received is recorded at the book value of the assets surrendered, and no gain is recognized. If PMD had received cash in the exchange, a limited gain would be recognized in accordance with paragraph 22. From the point of view of Dealer Corporation, the transaction is treated as an ordinary sale of inventory, i.e., the basic principle is applied. Table I. Capettini and King Treatment
PMD Corporation
Dealer Corparatian
DetiveryY&i&?, fww 837,000 ~~~~~~~~t~ ~~~r~ciai~#~ $38,000
Cash
$ 5,~O Delivery vehicle, old
&?hide~~~~~~ Sales
$ 5,000
$%WKJ $2i,OOO
$30,000 Cost crfGoods Sold Vehicle inventory
Hf&bs and ~~~~~~~~~T~ PMD Ccrporatim
Dslivery vehicle, nsw Accumulated depreciation Cash DetiveFy vehicle, aid Gain 01strade-in
$21,000 $18,000
$18,BOQ $18,600
~~~t~~~ Deafer Oxpimtion
Cash Vehicle inventory Sales
$ 5,000 $~~,~OO $ 4,000 Cost of i33ods Soid Vefiicle ~#v~nt~~
$ 5”OQO $16,000 $21,000 ~I~*~ $18,BO
The Hobbs and Bainbridge (1982) method views the exchange as a nonsymmetrical transaction between a dealer and a nondealer thus culminating the earnings process for bath, and requiring application of the basic principle. Similarly, the EITF view is that this transaction fails the “same line of business” test, and is therefore not an exchange of similar assets. Again, as in Hobbs and Bainbridge (1982) the basic principle applies to the transaction. The result is that a gain on the trade-in is fully recognized by PMD as: Gain = ($I6,~
- $12,000) = $4,000
and the new delivery vehicle is recorded at the market value of the asset relinquished plus any case given (less any cash received). Once again, Dealer Corporation records a sale of inventory. Our survey of the current editions of 15 financial accounting texts at both the intermediate and elementary levels found that 14 would incorrectly account for the transaction in the manner suggested in Capettini and King (1976). Oniy Smith and Skousen (1990) suggest the treatment outlined in Hobbs and Bainbridge (1982) and required under EITF Issue Summary 86-29 (1986). The erroneous treatments in the remaining 14 texts are classified in Table 2. Exchanges between a dealer and nondealer (trade-ins) are Table 2. Treatments in texts where book vaIues are used because assets exchanged are similar
Kieso and Weygandt (1989)” Nikolai and Bazley (1988) Welsch and Zlatkovich (1989) W~fliam~, Stanga, Holder (I 989) Chasteen, Flaherty, O’Connor (1989) Mosich (1989) Danos and lmhoff (t986) Meigs and Meigs (1989) Larson (1989) Eskew and Jensen (1989) Short and Welsch (1990) Walgenbach and Hanson (1999) Stickney, Weil, Davidson (1991) Wallace (1990)
Column 1
Column 2
~aler/~ondeale~ Exchanges AFf5 Explicitly Identified
~ealer~~~nd~ter Exchanges Are Implied
X
X X :: X ::
X z :: X X
aKieso and Weygandt (1989) cover a deaier/nondealer exchange only where a loss is indicated on the exchange. They thereby avoid the issue since fair values mUSt be used in such an exchange. When a gain is involved they refrain from identifying the parties.
370
D. Marcinko and E. Petri
explicitly covered and iliustrated in those texts listed in Column 1 of Table 2, Each of these uses the exception to the basic principfe and accounts for the transaction using recorded vdues and deferring gain. The rationafe cited in each case is that the traded assets are similar in nature. The texts listed in Column 2 of Table 2 fail to identify the parties to the exchange. Instead, they provide various cIassification schemes for all uonmonetary exchanges. All exchanges of simifar productive assets where gain is indicated, incfuding by irnp~i~a~~o~those between a deaIer and nondeaIer. are cfassified as not ~ompieting the earnings process because of the similarity of the assets. As a result, trade-ins are erroneously accounted for as in the example above via the Capettini and King (1976) method. With the exception of Smith and Skousen (199Oj),the texts surveyed also fail to give proper consideration to the relevance of the amount of cash invoIved in the transaction, To ihustrate the “‘25% Rule” required by EITF 86-29 (1986) consider the following transaction data. Firms A and B, in the same line of business, exchange fork lifts with the following characteristics: Book V&e Fork Lift Relinqu~sb~d By A Fork Lift Relinquished By I3
S 5,000 $20,QOO
Market Value ~~~,~~ $25,000
In addition, A pays B $14,000 in cash. Prior to EITF 86-29 (1986), this exchange was accounted for as it nonmonetar~ transacfion using book vafues, The recipient of boor recognized a portion of the gain on the transaction in accordance with APB0 29, Paragraph 22 (1973). The journai entries are given in TabIe 3, Panel A. In this transaction, the amount of cash received by firm B is 60% of the tota fair value received. Thus, the “25% Rule” of EITF 86-29 (1986) applies and the exchange is now viewed as a monetary transaction. As such it is recorded at fair v&es as shown in Table 3. Panef B. CONCLUSIONS A significant period of time has passed since the Hobbs and Bainbridge ~I9~2~ revelation and the issuance of EfTF Issue S~rna~ 86-29 (19865 NonetheIess, confusion stiI1 reigns. The phrase ‘~~~Imination of the earnings process” has not been clarified and in most texts is predicated on the limiting condition of the dissimilarity of the assets exchanged, ignoring the impact of the asymmetry between the parties and the “same line of business test.” The result is that the treatment of trade-in transactions is stiIt inadequate. Likewise, the pedagogic I~~era~urehas faifed to incorporate the sim~I~~~ation offered by the “25% Rule” regarding the significance of boot in
Nonmonetary Exchanges
371
Table 3. Illustrating the 25% rule Panel A-Nonmonetary Company A
Fork Lift (now)
Fork Lift (new)
$20,000
Fork Lit (oidf Cash
Transaction Company B
;,&@I@
Cash ‘Gain
+ Fair Market Value
= Gash -
Of NMA Received >
Gain = $15,000
-
$15,000 K $15,000
+ $10,000 >
Panel B-Monetary
$20,000 $ 3,000’ Book Value of
x NMA Relinquished
x $20,000
1
= $3,000 I
Transection
Compsny A Fork Lift (new) Fork Lift (old) Cash Gain
$ 8,000 $15,000
Cash Fork Lift (old) Gain
Company B
$25,000 $ 5,000 $15,000 $ 5,000
Fork Lift (new) Cash Fork Lift (old) G&l
$10,000 $15,000 $20,000 $ 5,000
an exchange transaction. Hopefully, text authors will recognize that these changes produce a consistent and understandable approach to accounting for nonmonetary exchanges, and this will lead to improvements in both teaching and practice. REFERENCES Accounting Principles Board (1973). Opinion No. 29, accounting for nonmonetary fransactions. New York: American Institute of Certified Public Accountants. Capettini, R., % King T. E. (1976, January). Exchanges of nonmonetary assets: Some changes. The Accrrunting Review, 142-147. Chasteen, L., Ffaherty, R., & O’Connor, M. (1983). ~n~e~~e~~~~eaccounting (3rd ed.). New York: Random House. Danos, P., & Imhoff, E. (t986). ~~~e~rnedi~~e accounting (2nd ed.). Englewood Cliffs, NJ: Prentice-Hall. Emerging Issues Task Force. (1986). Nonmonetary transactions magnitude of boot and exceptions to the use of fair value, EITF Issue Summary 86-29. Stamford, CT: Financial Accounting Standards Board. Eskew, R., & Jensen, D. (1989). Fimmciai accounting (3rd ed.). New York: Random House. Hobbs, J.* & &&bridge, D. (1982, January). Nonmonetary exchange transactions: Cfarification of APB Qpinion 29. The Accounting Review, pp. I71-175. Kieso, D., 18Weygandt, J. (1989). Intermediate accounting (6th ed.). New York: John Wiley & sons. Larson, K. (1989). Financialaccaunting (4th ed.). Homewood, IL: R. D. Irwin. Meigs, R., & Meigs, W. (1989). Financialaccounting (4th ed.). New York: McGraw-Hill.
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D. Marcinko and E. Petri
Smith, J., & Skousen, K, (1990). Intermediate nccounfing (Khh ed.). Cincinnati, OH: SouthWestern Co. Sterling R. (1970, July). On theory construction and verification. The Accounting Review, pp. 444-457.
Wallace, W. (1990), Financial accounting!. Cincinnati, OH: South-Western Co. Welsch, G., & Zlatkavich C. (1989). Inte?mediute accounting (8th ed.). Homewood, IL: R. D. Irwin.
Abs~ac~ Accounting for certain nonmonetary exchwrnges has fang been n~.&t~d by ccmfu&n and controversy. The wording of Accounting Frirlciples Board Opinic)* No. 29 (APB0 29) is especially ambiguous as to when an earnings procpss is culminated, and therefore as to when n iransaetion is rec&ed a* market ur a?nek dws. SWcm&tg academic a& pedagogic &etafnz Aas seized aa &e d~ss~rn~~~t~& @KC as~bs ex&aaged as being mxess~ and sufficient tct retarding at fair x&es. Thftisz-$x%~e, un~~~~na~~~~~fa%s to capSure I& ecn%?mic SUbsrmW%of the transa~~~~n* This has been pointed auf by FIabbs and Bainbr~~~~ (E982) and fwtb.” clarified by the Emerging Issuer Task Force (Ef’TP) of the Financial. Accounting Standards Board @‘A!%) (1986). The purpose of this paper is; to bring the proper treatment of such transactions la rbe attention of ficccounting educators SDthat the pedagogic literature may be ap~~~~~~~~ adjust&.
INTRODUCTION AND OVERVIEW OF THE PRIC”rHtEM “We 02?serveac&Quntatnts’ actkms tu discover what to teach, then we teach tlwl Ixm to- act, tlB% we observe a~~o~tan~~ aems EC3disQver what to teach If This commentby Sterling qr9-m) effectively ~~~~~~ L
_
-
the dynN&s of current confusion over accounting for exchanges of nc)Wtmonetary assets. Wide variation in practice regarding the valuation of assets transferred in nonmonetary exchanges and the recognition of gains or losses cm swh bzmztctions, pxmpted the issuance of Accounting Princig&s Board Qpinion fA33.3~) No= 29 fH73). ~nbse~ne~~ ~~te~re~t~o~s af Opmiorr 53 and observ&on of practice h&s failed to produce a ~on~~~~~~ understandable method of capturing the economic substance of certain nonmonetary exchanges, In a frequently cited paper on the topic, Capettlni and King (1976, p. 142) noted early difficulties observing that: “ . . . sumo parts of &e Opinion C&s&w w&b ~~~~~~~~a~ exchmgkxi are quite difficult to interpret* and ewzn the new ewons of ~~~~~~~~~~~ acmrmting text9 . - - f&iito present an ~d~~~ate exp~anat~~~. _ _ . ” In Capertini and King”s (19%) view, exchanges of similar productive assets are to be accounted for at recorded values. The approach results irk deferral of gain in trade-in type transwtions involving similar productive
366
D. Marcinko and E. Petri
assets.’ This represents a broad interpretation of Paragraph 3 of Opinion 29 which defines GmiIar prod~~ve assets as being: a) of the sme genera% type, b) p~f~~~ng the same function, or c) used in the same fine of business. Thus, the same type at’ asset used in djfferent lines of business to perform different functions would still be treated as similar since it would qualify under item (a). Our review of the current textbook literature found that this treatment dominates the discussion of trade-in transections. In those texts where trade-ins are not expiicit@ covered, s~rn~~~~t~of the assets is viewed as a sufficient condition to account for an exchange by using recorded rather than fair vaiueXjl. Hobbs and B&bridge (1982) challenged the Capettini and Ming (1976) interpretation of what type of transaction culminated the earnings process. Direct comrn~~c~t~on with three Board members by Hobbs and Bambridge reveafed that the rnod~f~cat~o~ to the basic pr~~c~p~eapp%s on& when the relationship between the transacting parties is symmetrical, Le,, two dealers or two nondealers in the assets exchanged. They quote the foIlowing passage from the response to their inquiry:
In a trade-in transaction3 the earnings process is culminated for the dealer. The Hobbs and Bainbridge (1982) disclosure makes it clear that in such a &nation the basic principle must be used by the nondealer as wefl as the de&er, Restated, this new information ~~a~~~s~~ that tke ~u~rn~nat~o~ of the earnings process and thus use of the b&c principle occurs in either of the following situations: 1, When the relationship between the parties Is asymmetrical, or 2. When the ~~oductjve assets exchanged are dissimUar. More recently, FASB Emerging Issues Task Force Issues ~~mrna~ 863~ (1986) has moved in the same direction taken by Hobbs and Bainbridge (1982). Prompted by an expreg8sd need to narr~~w practice, the Emerging Issues Task Force (EITF) reached consensus on several questions regarding ~o~rnonet~y exchanges, including whether aa enterprise should record a fixed asset ac4uired in exchange for another fixed asset at the cust of the fixed asset transferred or at fair vahre. Trade& transactions fail into this category. In considering the question, the Task Force has narrowed the
Nonmonetary Exchanges
367
meaning of the phrase “similar productive asset” to focus on whether or not the productive assets exchanged are used in the “same line of business.” As stated, paragraph 3 of Opinion 29 (1982) broadly defined similar productive assets as those which satisfy any one of the three following conditions: 1. Assets that are of the same general type; 2. Assets performing the same function; 3. Assets employed in the same line of business. Issue Summary 86-29 (1986, pp. 6-7) sets forth two necessary conditions: The modification of the basic principle may be used if and only if the fixed assets exchanged are similar and are employed in the same line of business. This has led to the adoption of a “same line of business” test that requires recording at book values (modification of the basic principle) if the exchange involves similar fixed assets used in the same line of business. In the absence of either of these two conditions, fair market value is used. The EITF has sharpened the criteria presented in Hobbs and Bainbridge (1982). No longer is it necessary to speculate as to what is meant by a symmetric relationship between trading parties. Once the parties establish that similar productive assets used in the same line of business are being exchanged, the proper accounting treatment for the transaction is determined. The authoritative nature of Issue Summary 86-29 (1986) requires that these new criteria be adopted by the authors of financial accounting texts in order to promote wider dissemination and the narrowing of practice desired by the EITF. The same Issue Summary also has addressed the question of how much boot may be involved for the transaction to be considered nonmonetary (1986, pp. 10-13). It establishes a threshold of 25% of the total fair value exchanged for determining when boot is significant. If the amount of boot exceeds this 25% threshold, the exchange is monetary and must be recorded at fair value by both the recipient and payer of boot. This decision, therefore, needs to be incorporated into the text literature to reduce confusion. The EITF Issue Summary (1986) finally produces a workable set of criteria for deciding between the basic principle and its modification. For the paragraph 21 exception to the basic principle to apply, all of the following conditions must be satisfied by the party concerned: The assets exchanged must be similar and used in the same line of business by both parties to the exchange; there must not be a loss on the exchange; and, the amount of boot involved (if any) must be less than 25% of the total fair value exchanged.2 *A given transaction satisfying these conditions may involve a loss for one party and a gain for the other. Under these conditions, Issue Summary 86-29 (1986) implies that the party that has incurred the loss will record at market values, while the party realizing a gain will apply the paragraph 21 exception.
D. Marcinko and E. Petri
368
THE DIFFERENCE BETWEEN THE CAPETTINf AND KING AND HOBBS AND ~A~~B~~D~E~E~TF T~AT~~E~ In order to illustrate the treatment of a trade-in consistent with the EITF Issue Summary (1986) and Hobbs and Bainbridge (1982), assume the following facts concerning a particular transaction. PMD Corporation, a manufacturer of quality furniture, trades in its old delivery vehicle and pays $5,000 cash to Deafer Corporation for a new delivery vehicle. The old delivery vehicle’s a~~~is~t~~~ ectst to PMD Corporation was $30,000, and depreciation of $18,000 had accumulated up to the date of the exchange. A trade-in allowance of $18,500 is negotiated with DeaIer Corporation. The fair market value of this vehicle is $16,000. Dealer Corporation was asking $23,500 for the new vehicle which has an invoice cost of $f8,600. The entries in Table 1 compare the Capettini and King and the Hobbs and Bainbridge/EITF methods of recording the transaction for both companics . Based on the conclusion that the exchange of physically similar productive assets does not culminate the earnings process, Capettini and King apply the modification of the basic principle to the PMD Corparation- The asset received is recorded at the book value of the assets surrendered, and no gain is recognized. If PMD had received cash in the exchange, a limited gain would be recognized in accordance with paragraph 22. From the point of view of Dealer Corporation, the transaction is treated as an ordinary sale of inventory, i.e., the basic principle is applied. Table I. Capettini and King Treatment
PMD Corporation
Dealer Corparatian
DetiveryY&i&?, fww 837,000 ~~~~~~~~t~ ~~~r~ciai~#~ $38,000
Cash
$ 5,~O Delivery vehicle, old
&?hide~~~~~~ Sales
$ 5,000
$%WKJ $2i,OOO
$30,000 Cost crfGoods Sold Vehicle inventory
Hf&bs and ~~~~~~~~~T~ PMD Ccrporatim
Dslivery vehicle, nsw Accumulated depreciation Cash DetiveFy vehicle, aid Gain 01strade-in
$21,000 $18,000
$18,BOQ $18,600
~~~t~~~ Deafer Oxpimtion
Cash Vehicle inventory Sales
$ 5,000 $~~,~OO $ 4,000 Cost of i33ods Soid Vefiicle ~#v~nt~~
$ 5”OQO $16,000 $21,000 ~I~*~ $18,BO
The Hobbs and Bainbridge (1982) method views the exchange as a nonsymmetrical transaction between a dealer and a nondealer thus culminating the earnings process for bath, and requiring application of the basic principle. Similarly, the EITF view is that this transaction fails the “same line of business” test, and is therefore not an exchange of similar assets. Again, as in Hobbs and Bainbridge (1982) the basic principle applies to the transaction. The result is that a gain on the trade-in is fully recognized by PMD as: Gain = ($I6,~
- $12,000) = $4,000
and the new delivery vehicle is recorded at the market value of the asset relinquished plus any case given (less any cash received). Once again, Dealer Corporation records a sale of inventory. Our survey of the current editions of 15 financial accounting texts at both the intermediate and elementary levels found that 14 would incorrectly account for the transaction in the manner suggested in Capettini and King (1976). Oniy Smith and Skousen (1990) suggest the treatment outlined in Hobbs and Bainbridge (1982) and required under EITF Issue Summary 86-29 (1986). The erroneous treatments in the remaining 14 texts are classified in Table 2. Exchanges between a dealer and nondealer (trade-ins) are Table 2. Treatments in texts where book vaIues are used because assets exchanged are similar
Kieso and Weygandt (1989)” Nikolai and Bazley (1988) Welsch and Zlatkovich (1989) W~fliam~, Stanga, Holder (I 989) Chasteen, Flaherty, O’Connor (1989) Mosich (1989) Danos and lmhoff (t986) Meigs and Meigs (1989) Larson (1989) Eskew and Jensen (1989) Short and Welsch (1990) Walgenbach and Hanson (1999) Stickney, Weil, Davidson (1991) Wallace (1990)
Column 1
Column 2
~aler/~ondeale~ Exchanges AFf5 Explicitly Identified
~ealer~~~nd~ter Exchanges Are Implied
X
X X :: X ::
X z :: X X
aKieso and Weygandt (1989) cover a deaier/nondealer exchange only where a loss is indicated on the exchange. They thereby avoid the issue since fair values mUSt be used in such an exchange. When a gain is involved they refrain from identifying the parties.
370
D. Marcinko and E. Petri
explicitly covered and iliustrated in those texts listed in Column 1 of Table 2, Each of these uses the exception to the basic principfe and accounts for the transaction using recorded vdues and deferring gain. The rationafe cited in each case is that the traded assets are similar in nature. The texts listed in Column 2 of Table 2 fail to identify the parties to the exchange. Instead, they provide various cIassification schemes for all uonmonetary exchanges. All exchanges of simifar productive assets where gain is indicated, incfuding by irnp~i~a~~o~those between a deaIer and nondeaIer. are cfassified as not ~ompieting the earnings process because of the similarity of the assets. As a result, trade-ins are erroneously accounted for as in the example above via the Capettini and King (1976) method. With the exception of Smith and Skousen (199Oj),the texts surveyed also fail to give proper consideration to the relevance of the amount of cash invoIved in the transaction, To ihustrate the “‘25% Rule” required by EITF 86-29 (1986) consider the following transaction data. Firms A and B, in the same line of business, exchange fork lifts with the following characteristics: Book V&e Fork Lift Relinqu~sb~d By A Fork Lift Relinquished By I3
S 5,000 $20,QOO
Market Value ~~~,~~ $25,000
In addition, A pays B $14,000 in cash. Prior to EITF 86-29 (1986), this exchange was accounted for as it nonmonetar~ transacfion using book vafues, The recipient of boor recognized a portion of the gain on the transaction in accordance with APB0 29, Paragraph 22 (1973). The journai entries are given in TabIe 3, Panel A. In this transaction, the amount of cash received by firm B is 60% of the tota fair value received. Thus, the “25% Rule” of EITF 86-29 (1986) applies and the exchange is now viewed as a monetary transaction. As such it is recorded at fair v&es as shown in Table 3. Panef B. CONCLUSIONS A significant period of time has passed since the Hobbs and Bainbridge ~I9~2~ revelation and the issuance of EfTF Issue S~rna~ 86-29 (19865 NonetheIess, confusion stiI1 reigns. The phrase ‘~~~Imination of the earnings process” has not been clarified and in most texts is predicated on the limiting condition of the dissimilarity of the assets exchanged, ignoring the impact of the asymmetry between the parties and the “same line of business test.” The result is that the treatment of trade-in transactions is stiIt inadequate. Likewise, the pedagogic I~~era~urehas faifed to incorporate the sim~I~~~ation offered by the “25% Rule” regarding the significance of boot in
Nonmonetary Exchanges
371
Table 3. Illustrating the 25% rule Panel A-Nonmonetary Company A
Fork Lift (now)
Fork Lift (new)
$20,000
Fork Lit (oidf Cash
Transaction Company B
;,&@I@
Cash ‘Gain
+ Fair Market Value
= Gash -
Of NMA Received >
Gain = $15,000
-
$15,000 K $15,000
+ $10,000 >
Panel B-Monetary
$20,000 $ 3,000’ Book Value of
x NMA Relinquished
x $20,000
1
= $3,000 I
Transection
Compsny A Fork Lift (new) Fork Lift (old) Cash Gain
$ 8,000 $15,000
Cash Fork Lift (old) Gain
Company B
$25,000 $ 5,000 $15,000 $ 5,000
Fork Lift (new) Cash Fork Lift (old) G&l
$10,000 $15,000 $20,000 $ 5,000
an exchange transaction. Hopefully, text authors will recognize that these changes produce a consistent and understandable approach to accounting for nonmonetary exchanges, and this will lead to improvements in both teaching and practice. REFERENCES Accounting Principles Board (1973). Opinion No. 29, accounting for nonmonetary fransactions. New York: American Institute of Certified Public Accountants. Capettini, R., % King T. E. (1976, January). Exchanges of nonmonetary assets: Some changes. The Accrrunting Review, 142-147. Chasteen, L., Ffaherty, R., & O’Connor, M. (1983). ~n~e~~e~~~~eaccounting (3rd ed.). New York: Random House. Danos, P., & Imhoff, E. (t986). ~~~e~rnedi~~e accounting (2nd ed.). Englewood Cliffs, NJ: Prentice-Hall. Emerging Issues Task Force. (1986). Nonmonetary transactions magnitude of boot and exceptions to the use of fair value, EITF Issue Summary 86-29. Stamford, CT: Financial Accounting Standards Board. Eskew, R., & Jensen, D. (1989). Fimmciai accounting (3rd ed.). New York: Random House. Hobbs, J.* & &&bridge, D. (1982, January). Nonmonetary exchange transactions: Cfarification of APB Qpinion 29. The Accounting Review, pp. I71-175. Kieso, D., 18Weygandt, J. (1989). Intermediate accounting (6th ed.). New York: John Wiley & sons. Larson, K. (1989). Financialaccaunting (4th ed.). Homewood, IL: R. D. Irwin. Meigs, R., & Meigs, W. (1989). Financialaccounting (4th ed.). New York: McGraw-Hill.
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D. Marcinko and E. Petri
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Wallace, W. (1990), Financial accounting!. Cincinnati, OH: South-Western Co. Welsch, G., & Zlatkavich C. (1989). Inte?mediute accounting (8th ed.). Homewood, IL: R. D. Irwin.