 Hello and welcome to this session in which we would look at non-monetary exchanges. This topic gives students difficulty for several reasons. One, it involves gain and losses. Two, it involves commercial substance versus non-commercial substance. And in some transaction, although the transaction is non-monetary, cashed might be paid or cashed might be received. So given all these three levels together, gains and losses, commercial substance and cash, it will give students some difficulty analyzing and recording the transaction. On farhatlectures.com, whether you are a CPA candidate or an accounting student, I can help you with this topic. I can explain the topic to you in details in contrast to your CPA review course. If you're studying for your CPA review course, I cannot replace your CPA exam review course. What I can do, I can be an alternative explanation, a backup explanation, a useful addition. I can explain the material differently, which will help you with your CPA review course. My material is organized to mirror image your course. So if you are stuck in your course somewhere, you can go to my material and I will can give you an alternative explanation. My subscription is monthly. So you can try me for a month, you like it, you keep it. That's your risk. If not, you cancel and your potential gain is passing the exam. And if not for anything, take a look at my website to find out how well your university is doing on the CPA exam. Please take a look at my website also for other resources. I do have courses for other topics as well. Connect with me on LinkedIn if you haven't done so. And take a look at my LinkedIn recommendation. Students that actually use my material to pass the CPA exam, like this recording, connect with me on LinkedIn, Instagram, Facebook, as well as Twitter. Let's take a look at this first question. The questions will start always easy. And this is basically on the exam. It will start easy. Then it will start to become a little bit more difficult. So first they might ask you, they might ask you a question like this. If you don't know the answer, then they will start to notice that you are weak in non monetary exchanges. So let's start with this question and see if you can answer this question. What is the basic principle used to value an asset acquired in a non monetary exchange? First of all, what is a non monetary exchange? Non monetary exchange is when you give a non monetary asset and you would receive a non monetary asset. It's an exchange. Non means it doesn't involve money. Again, some transaction would involve money, but the majority of the transaction, the value of the transaction, the majority of its value is non monetary. Simply put, you are exchanging a truck for another truck or for a truck for two old trucks for a new truck. This is non monetary exchange. So what's the basic principle? Well, how do you value? In other words, when you record the transaction, how do you value? This is important and we're going to do certain journal entries, several journal entries explaining this, but what is the basic principle? Well, the basic principle is this. Please listen to me carefully and try to understand it. You're going to value the transaction based on the fair value that you gave up. This is the basic principle. So the answer is fair value of the asset given up. Simply put, how much did you give up? Simply put, let's keep it simple. Let's assume you purchase something for $500 cash. You gave up $500 and you received something. I don't care what it is. I don't care what that something is, but you paid $500. That something is worth $500. And when you do a non monetary exchange, what matters is the fair value of what you gave up. And that's how you would record your transaction. It does not matter what the other people think about their fair value. If they agree to your fair value, that's the true fair value. It doesn't matter. If I gave you, if I said I gave you $500 and you gave me something, you think it's worth $5,000. You think it's worth $5,000. That's fine. I think it's worth $500. It's worth $500. I don't care what you think it's worth. It's worth what I paid for it. I paid for it $500. The same concept applies in non-monetary exchanges. And this is an important concept to understand as you are going through this topic. It's not the book value of the asset plus any cash or other monetary consideration. It's the fair value of the asset. If the fair value is here, then the transaction will be correct. Fair value or book value, whichever is smaller, no, that's not how it works. A book value of the asset giving, no. It's fair value, not the asset, not the only asset giving, anything else is giving in addition to the asset. So notice and B, if we can say fair value plus, so you may give the older truck, which has a fair value, plus you may add some cash. Well, if that's the case, then what you are getting is the value of the fair value of the older truck plus any cash plus any other monetary consideration. If you received anything, for example, they removed your liability. That also, as if they gave you money, if they take over your liability. So the answer is it's valued at the fair value of the asset given up. I know I'm taking a little bit longer to explain this topic because it's going to get easier when you work with numbers. In a non-monetary exchange of equipment, if the exchange has commercial substance, now what does that mean, commercial substance? It means that your cash flow position will change as a result of this transaction. The cash flow timing and amount will change. It means this transaction made an effect in terms of cash flow, in terms of timing, in terms of amount. So you're going to be receiving more cash or for a longer period of time. Therefore, it has commercial substance. So if the transaction has a commercial substance, a gain is recognized if what? If it has commercial substance. Well, let's take a look. If the fair value of the asset received exceeds the fair value of the equipment received exceeds the book value of the equipment received. Now, when you determine the gain or the loss, you don't look at the asset received. You determine the gain or the loss based on the asset that you gave up. So this is incorrect. Okay. The book value of the equipment received. Now, it doesn't matter. Once I see received, the gain and the loss is determined based on the asset that you're given up. The fair value of the equipment surrendered, this is given up, exceeds the book value of the equipment given up. Yes, basically, it's the fair value. What are you given up, surrendering, giving up versus the book value of the asset given up. So if you gave up an asset with a book value of 10,000, this is the book value, and it has a fair value of 12,000, you have a gain of 2000. Now, this is the gain. If this exchange, if you exchange this asset and the exchange they told you in the problem, it has commercial substance, then a gain is recognized. This is how you recognize a gain. The fair value of the asset given up, surrendering the asset is greater than its book value, you have a gain. And if you have a gain, it is recognized when the transaction has commercial substance. So are you saying if the transaction does not have a commercial substance, does not have a commercial substance, or what we called lax commercial substance, what happened, then no gain is recognized. Under those circumstances, the gain would reduce the new fair value of the new asset. And we'll work an example, if not, if you want to learn a little bit more about the rules, because there's a lot involved here, go to farhatlectures.com. Let's start to apply what we just learned. Adam Company Exchange Equipment and 17,800 cash for similar equipment. The book value and the fair value of the old equipment were 80,200 and 90,000 dollar. Assuming that the exchange has commercial substance, Adam would recognize again or a loss of how much. The first thing you have to do in any transaction is determine the gain or the loss. So how do we determine the gain or the loss? As I just told you, you would look at the asset given up, the asset surrendering, and you are the book value and the fair value of the old equipment, the book value. So the difference between 92,000 is our book value, our fair value, 92,000 is the fair value minus 80,200. The book value will give us 11,800. Therefore, we have a gain, notice here, they're trying to trick you, negative 11,000, which is a loss or positive, it's a gain of 11,800. So this is how you will book this transaction. Now, I'm going to go a step further, although they're only asking you for the gain. If I ask you to journalize this transaction, will you be able to journalize this transaction? Simply put, what is the value of the new equipment? What's the value of the new equipment? So what's the new equipment? So how much do you debit the new equipment? Let's first get rid of the old equipment. The old equipment, we're going to credit old equipment, 80,200. We credit cash, 17,800. We have a gain of 11,800 and we know we're going to record the gain because the gain we said it has commercial substance. Now, what about the new equipment? How much would you record the new equipment for? And obviously at this point, it's easy because you add all the sub because that's the debit, that's the debit that's missing. But simply put, what you do is you take the fair value of the asset given up. Remember, the fair value of the asset given up, remember, we recorded that fair value of the asset given up, 92,000, the fair value of the asset given up. But remember, you also gave up, it's not only you gave up the asset, you gave up cash. Remember, you exchange it also for cash. So you paid cash. So this is how much you paid for the, you paid, you paid for the asset. So let's take a look at this, 92,000 plus 17,800 equal to 109,800. Now, we want to make sure that this transaction balances minus 80,200 minus 17,800 minus 11,800. Notice total debits equal total credits. So these two equal to each other. But I told you at this point, if you could do these three entries, the new equipment is a plug-in 109,800 or I gave up 92,000 and I gave up cash. This is what I would record the new equipment at. Notice, notice, this is why I spend a little bit more time on this, on this question, fair value of assets given up. It's what I gave up. I gave up an asset worth 92,000 and cash. This is the new equipment will be recorded at that price. Adam exchange equipment 17,000 equipment and 17,000 cash for similar equipment. Looks like the other problem. The bulk value and the fair value of the old equipment were 80,300 and 90,700. Assuming the exchange lacks commercial substance. So the difference between this problem and the previous problem is it lacks commercial substance. Adam would record, is it a gain or a loss on the exchange? First, we have to determine whether we have a gain or whether we have a loss. Well, we have fair value of 90,700 minus 80,300. We have 16,000, oops, that doesn't sound right, 90,700 minus 80,300. So first, determine the gain or the loss. We have a gain of 10,400 and there is an insert of 10,400. There's also a loss of 10,400. We know it's a gain. Now, the difference between this transaction and the prior transaction is this transaction, it's telling you that the exchange lacks commercial substance. When the exchange lacks commercial substance, you cannot recognize the gain. So the answer is zero. Whoa, hold on. So why am I computing the gain if I'm not going to recognize the gain? And what am I going to do with this gain? Am I going to compute the gain? Say I have a gain then say, okay, I don't have to worry about this gain. No, I have the gain. But what I have to do, the gain will be at the third gain. Now, what does that mean the third gain? It means I'm going to push the gain down the road. How do I do so? Let me show you how am I going to push the gain down the road? Let's book this transaction. Well, we get rid of the old equipment. The old equipment has a book value of 80,300. We paid cash of 17,800. Now, how do we book the new equipment? Okay, how do we book the new equipment? We said in the old lesson, we said, we'll take the amount given up, okay, which is 90,700 plus 17,800. But here we have a gain that we are deferring. Okay, here's what's going to happen. So the gain we know the gain is 10,400. How do we record the new value? The new value, the new value, it's going to have what's called the third component. What do I mean by the third component? Okay, let's take a look at what we gave up. We gave up 90,700. We gave up cash of 17,800. Let's add those up. So if we take 90,700 plus 17,800 plus the cash, this is going to oops, plus. So 90,700 plus 17,800. That's going to give us 108,500. And I can assure you, if you put 108,500, the entry will not, the entry will not balance. The entry will not balance. As you can tell, 80,000 plus, 80,000 plus 17,000 is not equal to 108. So what do we have to do? Do you remember the gain that we said we have 10,400 of gain? What's going to happen with the gain? It's going to reduce the value of the equipment. And by reducing the value of the equipment, it means we are lowering our cost. Lowering our cost now with the result in an increase of gains in the future. And this is what we mean by deferring the gain. It means we're not going to recognize the gain until later. Later means when we sell this asset. But when we sell this asset, the asset, it's going to have a reduction in its value of 10,400. So let's do that minus 10,400 equal to 98,100 equal to 98,100. Let's see now if 98,100. So notice what I did is I, let me put this in a different color. All what I did is I took the gain and I deferred it. Deferred it means pushing the gain into the future. How do I push the gain into the future by reducing what the value of the asset should be? So 98,100 minus 80,300 to see if my entry balance minus 17,800 you got it. Okay, zero. So now my total debit is equal to my total credits. So the difference between this transaction and this transaction, this one I recognize the gain. If I did not recognize the gain, what I would do, I will take out the gain and I would reduce the new equipment. If this was lax, if this question was lax commercial substance, and this is what I did here. I did a transaction that lacks commercial substance. If it has commercial substance, then I will increase this by 10,400 and I would have a gain of 10,400. And in this way, the transaction will have a commercial substance. It has commercial substance. So that's why you have to know the difference, whether it has commercial substance or it doesn't. Now, in case of losses, I'm going to give you the tip. You would always recognize your losses. So it's easy with losses. Let's take a look at this question. Adam exchange all the equipment for new equipment into exchange transaction. We have equipment A and equipment B. So we're only looking for equipment A. So what would they record the new equipment at? And hopefully at this point, you became an expert in this. And by the way, I needed to maybe make a clarification about these exchanges. Everything I'm teaching you here is on the FAR exam or it's for GAP purposes. The reason I need to make this distinction is because if you are studying for RAG, the rules are a little bit different. So you have to follow the IRS. That's not what we are doing here. If you want to do that, look at my RAG courses or RAG lectures. So how much would they record the new equipment at? Well, let's see. How much do we record the new equipment at? At the value of the value that we gave up. That's how we would record the transaction. This transaction has commercial substance. So the first thing you do is to determine whether you have a gain or a loss. So you have a fair value of 80, a book value of 75. Well, you have a gain. So first of all, we have a gain of 5,000. And we can recognize the gain. So what you need to do is start to enter the entry. We have a gain of 5,000. We know we received cash of 12,000. So cash is 12,000. We get rid of the old equipment for 75, old asset. And we credit that 75. Well, at this point, if you are stuck, guess what? You'll count it for everything. So this is 80. And therefore, all we're missing is a debit of 80. It means we are missing a debit of new equipment of 68. So the new equipment is recorded at 68. Whoa, whoa, whoa. Hold on. Didn't you just said that it's based on what you gave up? I gave up an asset worth of 80,000. Why am I recording the new asset at 68? New equipment? Well, the reason you are is because in addition to the, in addition to the asset that you received, they gave you cash. So between those two, you did receive 80,000 and you did receive what you gave up. Okay? So notice here, once again, you might be saying, Professor Farhad, you said we record the new asset based on the based on the value that we gave up. And you're saying, you know, we gave up 80, we are recording it on 68. You did. But look, they gave you an additional 12,000. So you did indeed record 80,000 of new asset on your books. They're not all in physical asset, they gave you some cash. Okay? But if you did observe this, that's a good thing because generally speaking, what you give up, the fair value of the give up should equal to the fair value of what you received. At the end of this recording, I'm going to remind you again that if you are a CPA candidate or an accounting student, I strongly suggest you check out my website, farhadlectures.com. I can help you pass the exam by giving you alternative explanation, detailed explanation. Good luck, study hard, invest in your CPA. It's a long term investment in your career 20 to 30 years. Don't shortchange yourself and stay safe.