EXCHANGE OF PROPERTY, PLANT AND EQUIPMENT

Under IAS 16 Property, plant and equipment, the cost of an item of property, plant and equipment acquired by way of exchange is measured at the fair value of the asset given up unless:

• the exchange transaction lacks commercial substance; or
• the fair value of the asset received and asset given up cannot be reliably measured. 

In this case, the acquired item is measured at the carrying amount of the asset given up.

This means that the cost or fair value of the item received is not relevant. The asset received will be measured either at the fair value or the carrying amount of the asset given up.

An exchange transaction has commercial substance if the risk, timing and amount of the cash flows of the asset received differs from those of the cash flows of the asset transferred.

For example, Entity A exchanges a house for a land owned by Entity B. The house is vacant whereas the land is rented out. This exchange transaction has commercial substance because the house does not generate cash flows but the land does. Therefore, Entity A would recognise the land received at the fair value of the house given up at the date of exchange.

Let's look at the following illustrations.

Illustration 1

Entity A exchanges a machinery for an equipment with Entity B. The carrying amount of the machinery at the date of exchange was $450,000 while its fair value was $600,000. The equipment on the other hand had a fair value of $800,000.

Required:

How should Entity A account for the equipment received:

(a) If the exchange has commercial substance?

(b) If the exchange has no commercial substance?

Solution

(a) The equipment received will be measured at the fair value of the machinery given up, i.e.

     $600,000. A gain of $150,000 would be charged to profit or loss representing the gain on

     disposal of the machinery.

     The accounting entries are as follows:

	Dr	Equipment	$600,000
	Cr	Machinery	$450,000
	Cr	Profit or loss (Gain on disposal of machinery)	$150,000

(b) The equipment received will be measured at the carrying amount of the machinery given up, i.e.
     $450,000. Therefore, no gain or loss is recognised and only a reclassification is made as
     follows:

	Dr	Equipment	$450,000
	Dr	Machinery	$450,000

     Note that in both cases, the fair value of the equipment received, i.e. $800,000 is irrelevant.


Illustration 2

Jay exchanged one of its development plants for a piece of vacant land. The carrying amount and fair value of the plant at the date of exchange were $1 million and $1.5 million respectively. The land has a fair value of $2 million.

Required:
Explain how the exchange transaction will be accounted for in the financial statements of Jay.

Solution

The exchange transaction has commercial substance as the plant is generating cash flows but the vacant land is not. Therefore, the land acquired would be measured at the fair value of the plant given up, i.e. $1.5 million.

A gain of $500,000 would be charged to profit or loss representing the gain on disposal of the plant.

The accounting entries are as follows: 

	Dr	Land	$1,500,000
	Cr	Plant	$1,000,000
	Cr	Profit or loss (Gain on disposal of plant)	$500,000

Again, the fair value of the land received, i.e. $2 million is irrelevant.