ExpertHard1 markMultiple Choice
CPA · Question 20 · Area 2: Select Accounts
Company A exchanges a truck (Book Value $20,000, Fair Value $25,000) for a machine from Company B (Fair Value $22,000) and receives $3,000 cash. The exchange lacks commercial substance. What gain should Company A recognize?
Company A exchanges a truck (Book Value $20,000, Fair Value $25,000) for a machine from Company B (Fair Value $22,000) and receives $3,000 cash. The exchange lacks commercial substance. What gain should Company A recognize?
Answer options:
A.
$5,000
B.
$0
C.
$600
D.
$3,000
How to approach this question
1. Calculate Total Potential Gain (FV Old - BV Old). 2. Check Commercial Substance. No? -> 3. Was cash received? Yes -> 4. Calculate Boot Ratio (Cash / Total Consideration). 5. If Ratio < 25%, Gain = Total Gain * Ratio.
Full Answer
C.$600✓ Correct
C
When an exchange lacks commercial substance but cash is received, a partial gain is recognized. Ratio = Cash / (Cash + Asset Received) = 3k/25k = 12%. Gain = Total Gain ($5k) * 12% = $600.
Common mistakes
Recognizing full gain; recognizing zero gain; calculating ratio based on BV instead of FV.
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