Tax base
C Raw materials
4. Initial measurement
4.2 Method of acquisition The asset may be acquired by:
• paying an amount in cash (immediately or after a period of time, i.e. on credit);
• paying by exchanging another non-cash asset;
• government grant.
If the transaction is paid for in cash, the measurement of the asset is based on the cash amount. If, however, the asset is acquired by giving up a non-cash asset (e.g. machine), or if the government gave the asset to the entity, a fair value may be needed.
4.2.1 Cash
If the acquisition is paid for in cash, either immediately or within normal credit terms, then the asset is recorded at the cash amount. If a cash payment is deferred beyond normal credit terms, then the amount paid (nominal amount) must be present valued to the equivalent cash amount due on date of recognition. The difference between the present value and the actual amount that will be paid is recognised as a finance charge.
Example 2: payment in cash – normal credit terms
A company purchased a machine for C100 000. There were no individually significant parts.
The purchase price is payable within normal credit terms.
Required:
Show the journal entries relating to the purchase and payment of the machine.
Solution to example 2: payment in cash – normal credit terms
Debit Credit
Machine: cost (asset) 100 000
Trade accounts payable (liability) 100 000
Purchase of machine on normal credit terms
Trade accounts payable (liability) 100 000
Bank 100 000
Payment made to supplier of machine
Example 3: payment in cash – beyond normal credit terms
A company purchased a machine for C100 000. There were no individually significant parts.
The purchase price is payable after one year. This is considered to be a longer than normal credit term. The present value of this amount, calculated using 10%, being an appropriate rate of interest, is C90 909.
Required:
Show the journal entries relating to the purchase and payment of the machine.
Solution to example 3: payment in cash – beyond normal credit terms
Debit Credit
Machine: cost (asset) 90 909
Trade accounts payable (liability) 90 909
Purchase of machine on normal credit terms
Finance costs (expense) 9 091
Trade accounts payable (liability) 9 091
Finance costs on present value of purchase price: 90 909 x 10%
Trade accounts payable (liability) 100 000
Bank 100 000
Payment made to supplier of machine 4.2.2 Fair value
If the asset is not paid for in cash, or is not entirely paid for in cash, the fair value of the purchase consideration must be estimated. These include instances where the asset is acquired via
• an asset exchange; or
• a government grant (at either no value at all or at a nominal amount).
4.2.2.1 Asset exchange
When recording an asset acquired through an exchange of assets, the cost of the new asset will be the fair value of the asset/s given up. However, the fair value of the asset received must be used instead if:
• the fair value of the asset given up is not available; or
• the fair value of the asset received is ‘more clearly evident’.
In the event that the exchange of assets is deemed to have no commercial substance (e.g. two vehicles are exchanged, of the same vintage, with the same mileage and in the same condition), the cost of the asset acquired is the carrying amount of the asset given up.
An exchange is considered to have no commercial substance if the exchange of assets:
• will not change the future cash flows in any way (risk, timing or amount);
• will not change the value of the operation that is to use the asset; or
• any expected change in cash flows or value is insignificant relative to the fair value of the assets exchanged.
The following diagramme may help to simplify the treatment of exchanges of assets:
Exchange of assets
Use fair value Use carrying amount
• of the asset/s given up; or
• of the asset received – if this is more clearly evident
• use fair value only if it is reliably determinable (i.e. there are frequent similar market transactions or alternative estimates of fair value are possible)
• if the exchange lacks commercial substance (e.g. the assets are very similar);
• if the fair values of both assets were unable to be reliably determined
Example 4: exchange of assets where both fair values are known
A company exchanged machine A (given up) for another machine, machine B (acquired):
C Machine A:
Carrying amount (cost: C18 000 and accumulated depreciation: C8 000) Fair value
10 000 11 000 Machine B:
Fair value
12 000
The difference in fair values is considered to be immaterial.
Required:
Discuss how this exchange should be recorded, if at all.
Solution to example 4: exchange of assets where both fair values are known
The old asset must be removed from the books and replaced by the new asset at the fair value of the asset being given up, being C11 000. The journal entry will be as follows:
Debit Credit
Machine: cost (B) 11 000
Machine: cost (A) 18 000
Machine: accumulated depreciation (negative A) 8 000
Profit on exchange of assets (balancing) 1 000
Exchange of machines: machine B measured at FV of machine A
Comment: It is submitted that the intention of the wording is that the fair value of the asset given up should always be used, unless the difference between the fair value of the asset given up and the asset received are so materially different, that it is clear that the fair value of the asset received should be used instead. In this example, it is given that the difference between the two fair values of C1 000 is considered to be immaterial.
Example 5: exchange of assets where both fair values are known
A company exchanged machine A (given up) for another machine, machine B (acquired):
C Machine A:
Carrying amount (cost: C18 000 and accumulated depreciation: C8 000) Fair value
10 000 11 000 Machine B:
Fair value 15 000
The difference in fair values is considered to be material and the fair value of machine B is more clearly evident than the fair value of machine A.
Required:
Discuss how this exchange should be recorded, if at all.
Solution to example 5: exchange of assets where both fair values are known
The old asset must be removed from the books and replaced by the new asset at the fair value of the asset being acquired (since the difference in the fair values is considered to be material, the fair value of the asset acquired is considered to be more clearly evident than the fair value of the asset given up), being C15 000. The journal entry will be as follows:
Debit Credit
Machine: cost (B) 15 000
Machine: cost (A) 18 000
Machine: accumulated depreciation (negative A) 8 000
Profit on exchange of assets (balancing) 5 000
Exchange of machines: machine B measured at its fair value
Example 6: exchange of assets where the fair value of the asset given up is unknown A company exchanges machine A (given up) for another machine, machine B (acquired):
C Machine A:
Carrying amount (cost: C18 000 and accumulated depreciation: C8 000) Fair value is not reliably determinable
10 000 Machine B:
Fair value 12 000
Required:
Discuss how this exchange should be recorded, if at all.
Solution to example 6: exchange of assets where the fair value of the asset given up is unknown
The previous asset must be removed from the books and be replaced by the fair value of the newly acquired asset (since the fair value of the previous asset is not available), being C12 000. The journal entry will be as follows:
Debit Credit
Machine: cost (B) 12 000
Machine: cost (A) 18 000
Machine: accumulated depreciation (negative A) 8 000
Profit on exchange of assets 2 000
Exchange of machines: machine B measured at its fair value
Example 7: exchange of assets with no commercial substance
Assume that a machine, with a carrying amount of C45 000 (cost: C50 000 and accumulated depreciation: C5 000), is given in exchange for another similar machine. The exchange is considered to have no impact on future cash flows (or present value thereof) of the business as a whole.
Required:
Discuss how this should be recorded in the general ledger, if at all, assuming that:
A. the fair value of the machine given up is C30 000 (the fair value of the newly acquired machine is unavailable);
B. the fair value of the newly acquired machine is C30 000 (the fair value of the machine given up is unavailable); and
C. neither the fair value of the machine given up nor the machine acquired is available.
Solution to example 7A: exchange of assets with no commercial substance
If the difference is considered to be material and if the fair value is considered to be an indication of the impairment of the asset, the carrying amount of the asset being given up must first be impaired to its fair value. The journal would be as follows:
Debit Credit
Impairment loss (E) 15 000
Machine: accumulated depreciation and impairment loss (-A) 15 000 Adjustment for the impairment loss of machine given up:
C45 000 – C30 000 = C15 000
Solution to example 7B: exchange of assets with no commercial substance
The material difference between the carrying amount of the asset given up and the fair value of the acquired asset suggests one of two things. Either:
i. the two assets are truly similar but the asset given up is impaired; or
ii. the two assets are not truly similar and therefore the loss on exchange must result from a bad business decision (the entity disposed of the asset for less than its true value).
7B(i) The assets are truly similar
The fair value of the two machines should be similar. If the difference is considered to be material and if the fair value is considered to be an indication of the impairment of the asset, the machine given up will first have to be impaired to its fair value as follows:
Debit Credit
Impairment loss (E) 15 000
Vehicles: accumulated depreciation and impairment loss (-A) 15 000 Adjustment for the impairment loss of the machine given up:
C45 000 – C30 000 = C15 000
No further entry is required since the carrying amount of the previous machine has already been adjusted to the fair value of the newly acquired machine: C30 000.
7B(ii) The assets are not truly similar
If, although not reliably determinable, the fair value of the machine given up is alleged to roughly equate its carrying amount of C45 000 and the fair value of the acquired machine truly is C30 000, then the newly acquired machine must be measured at its own fair value (since this is more clearly evident or relevant than the fair value of the previous machine).
Debit Credit
Machine: cost (newly acquired) 30 000
Machine: cost (previous) 50 000
Machine: accumulated depreciation (previous) 5 000 Loss on exchange of machines (45 000 – 30 000) 15 000 Exchange of dissimilar machines
Solution to example 7C: exchange of similar assets where neither fair value is available No adjustment is needed since the new machine must be assumed to be worth the same as the carrying amount of the machine that was given up.
Example 8: exchange of assets involving cash and cash equivalents A company exchanged a vehicle and cash for a machine:
C Vehicle:
Carrying amount (cost: C18 000 and accumulated depreciation: C8 000) Fair value
10 000 10 000
Cash: 1 000
Machine:
Fair value unknown
Required:
Show the related journal entry.
Solution to example 8: exchange of assets involving cash and cash equivalents
Debit Credit Vehicle: accumulated depreciation and impairment loss 8 000
Vehicle: cost 18 000
Bank 1 000
Cost: machine (fair value of old vehicle + cash paid) 11 000 Vehicle and cash exchanged for a machine
Example 9: exchange of assets involving cash and cash equivalents
A company exchanged a one-of-a-kind vehicle, designed and built by the entity, together with C1 000 in cash for a machine.
C Vehicle:
Carrying amount (cost: C18 000 and accumulated depreciation: C8 000) Fair value (the vehicle is unique and there is therefore no active market for it)
10 000 unknown
Cash: 1 000
Machine:
Fair value 12 000
Required:
Show the related journal entry.
Solution to example 9: exchange of assets involving cash and cash equivalents
Debit Credit Vehicle: accumulated depreciation and impairment loss 8 000
Vehicle: cost 18 000
Machine: cost: (fair value of new machine) 12 000
Bank 1 000
Profit on exchange of assets 1 000
Machine and cash exchanged for a vehicle
Since the fair value of the asset given up is not available, the fair value of the acquired asset is used instead.
4.2.2.2 Government grants (IAS 20)
Government grants are often provided to assist businesses in starting up. This obviously benefits the business but also benefits the government through creation of jobs and thus a larger base of taxpayers.
Government grants can be analysed into two basic categories. Either the company is granted:
• the actual non-monetary asset such as a casino licence; or
• cash.
If the company is granted the actual non-monetary asset (e.g. a casino licence or land), the company will measure the transaction at the asset’s fair value and:
• debit the asset; and
• credit a deferred income (equity) account.
If the company is granted the actual non-monetary asset (e.g. a casino licence or land), but is required to pay a small sum of cash (a nominal amount), the company may choose to measure the asset at its fair value or at the nominal amount to be paid.
If the entity chooses to measure the asset at its fair value even though a small amount is paid for the grant, the journal is similar to the one above:
• debit the asset (fair value);
• credit bank (nominal amount); and
• credit a deferred income (equity) account (fair value – nominal amount).
If the entity chooses to measure the asset at the nominal amount to be paid for the grant, the journal is as follows (notice how the value of the grant is not recognised at all):
• debit the asset (at its nominal cost); and
• credit bank.
Example 10: grant asset – fair value or nominal amount
The South African government grants a South African company a licence to fish off the coast of Cape Town, South Africa.
The fair value of the licence is C50 000 and the company is required to pay a relatively small sum of C1 000 for the licence.
Required:
Show the journal entries assuming:
A. The company chooses to measure the licence at its fair value.
B. The company chooses to measure the licence at its nominal amount.
Solution to example 10A: grant asset – fair value
Debit Credit
Fishing licence (asset) Given 50 000
Deferred fishing income 50 000 – 1 000 49 000
Bank Given 1 000
Recognising the licence granted by the government at fair value
Solution to example 10B: grant asset – nominal amount
Debit Credit
Fishing licence (asset) Given 1 000
Bank Given 1 000
Recognising the licence granted by the government at nominal value
If the grant is cash to be used in the acquisition of another asset (as opposed to cash to be used to fund expenses or provided simply as financial assistance), the company will:
• debit bank with the grant (or debit another asset account if the grant is not cash); and
• credit the cost of the asset being subsidised (or credit a deferred income account).
Example 11: government grant to acquire an asset
The government grants the company C50 000 in cash in order to acquire a nuclear plant. The company then purchases the nuclear plant for C80 000.
Required:
Show the journal entries relating to the grant and the subsequent purchase of the nuclear plant.
Solution to example 11: government grant to acquire an asset
Debit Credit
Bank 50 000
Nuclear plant: cost 50 000
Receipt of government grant to acquire a nuclear plant
Nuclear plant: cost 80 000
Bank 80 000
Purchase of nuclear plant
Notice that the nuclear plant has a cost of C30 000 instead of C80 000 because the cost of its acquisition was subsidised by the government.