20.3 Nonmonetary Exchanges and Restructuring

Nonmonetary Exchanges and Restructuring

Transactions that do not involve cash present unique accounting challenges. ASC 845 (Nonmonetary Transactions) governs the exchange of nonmonetary assets (like land, equipment, or inventory), while ASC 420 (Exit or Disposal Cost Obligations) outlines the accounting for restructuring costs, such as plant closures and layoffs.

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1. Nonmonetary Exchanges (ASC 845)

A nonmonetary exchange occurs when an entity swaps a nonmonetary asset for another nonmonetary asset. The primary accounting issue is determining whether the transaction should be recorded at fair value (recognizing gains and losses) or at carrying value (book value) (deferring gains).

The Critical Threshold: Commercial Substance

An exchange has commercial substance if the configuration of future cash flows (their timing, amount, or riskiness) changes significantly as a result of the transaction.

• If the exchange has commercial substance: The transaction is accounted for at fair value. All gains and losses are recognized immediately.
• If the exchange lacks commercial substance: The transaction is recorded at the book value of the asset given up. All losses are recognized immediately, but gains are deferred unless boot (cash) is received.

Summary of Gain and Loss Recognition Rules

Measuring the New Asset's Cost

When fair value is used, the cost of the new asset is calculated as: Cost of Asset Received = Fair Value of Asset Given Up + Boot Paid - Boot Received (Note: If the fair value of the asset received is more clearly evident, it is used instead.)

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Nonmonetary Exchange Example: Has Commercial Substance

Gamma Corp exchanges an old delivery truck (Cost = $40,000; Accumulated Depreciation = $25,000; Book Value = $15,000) for a new specialized sorting machine. The fair value of the truck is $18,000, and Gamma pays $2,000 cash. The transaction has commercial substance.

1. Calculate Gain/Loss:
   • Fair Value of truck given up ($18,000) - Book Value of truck given up ($15,000) = $3,000 Gain.
2. Determine Cost of New Machine:
   • Fair Value of truck given up ($18,000) + Cash paid ($2,000) = $20,000.
3. Journal Entry:

• Dr. Sorting Machine (New): $20,000
• Dr. Accumulated Depreciation - Truck: $25,000
• Cr. Truck (Old): $40,000
• Cr. Cash: $2,000
• Cr. Gain on Exchange (Net Income): $3,000

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Nonmonetary Exchange Example: Lacks Commercial Substance (Boot Received < 25%)

Delta Inc. exchanges land (Book Value = $100,000; Fair Value = $150,000) for another plot of land (Fair Value = $135,000) plus $15,000 cash (boot). The exchange lacks commercial substance.

1. Calculate Total Potential Gain:
   • Fair Value given up ($150,000) - Book Value given up ($100,000) = $50,000 Total Gain.
2. Check the 25% Boot Threshold:
   • Boot Received / Total Consideration Received = $15,000 / ($135,000 land + $15,000 cash) = 10%.
   • Since 10% < 25%, only a proportional gain is recognized.
3. Calculate Recognized Gain:
   • Recognized Gain = $50,000 Total Gain * 10% = $5,000.
   • The remaining $45,000 of gain is deferred.
4. Determine Cost of New Land:
   • Cost = Book Value of Old Land ($100,000) - Boot Received ($15,000) + Recognized Gain ($5,000) = $90,000.
5. Journal Entry:

• Dr. Land (New): $90,000
• Dr. Cash: $15,000
• Cr. Land (Old): $100,000
• Cr. Gain on Exchange (Net Income): $5,000

(Verification: Fair value of new land $135,000 - Deferred Gain $45,000 = Carrying Value $90,000).

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2. Restructuring and Exit/Disposal Costs (ASC 420)

Companies frequently restructure operations, which may involve plant closures, product line discontinuations, or layoffs. Under ASC 420, restructuring costs are not recognized when management commits to a plan. Instead, they are recognized only when a liability is incurred (i.e., when there is a present obligation to transfer assets or provide services).

Types of Restructuring Costs and Recognition Criteria

1. One-Time Employee Termination Benefits:
   • If employees are not required to render future service (or will be retained for less than 60 days): The liability is recognized and measured at fair value at the date management communicates the termination plan to employees.
   • If employees must render service until they are terminated (more than 60 days): The liability is recognized incrementally over the future service period.
2. Contract Termination Costs (Other than leases):
   • Costs to terminate an operating contract: Recognized when the contract is terminated in accordance with contract terms.
   • Costs that will continue to be incurred without economic benefit (e.g., an onerous contract): Recognized at fair value when the entity ceases using the rights conveyed by the contract.
3. Costs to Consolidate Facilities or Close Locations:
   • Costs such as relocating equipment or employees are recognized when they are actually incurred. They cannot be anticipated or accrued in advance.

Restructuring Presentation and Disclosure

• Restructuring and exit costs are reported as a component of income from continuing operations before income taxes on the income statement.
• Extensive notes must disclose the description of the exit/disposal activity, the total amount expected to be incurred, a reconciliation of the beginning and ending liability balances, and where the costs are presented in the income statement.