Question

Harper is contemplating exchanging a machine used in its operations for a similar machine on May 31. Harper will exchange machines with either Austin Corporation or Lubin Company. The data relating to the machines are presented below. Assume that the exchanges would have commercial substance.

Harper
Austin
Lubin
Original cost of the machine
H - $162,500
A - $180,000
L - $150,000
Accumulated depreciation thru May 31
H - 98,500
A - 70,000
L - 65,000
Fair value at May 31
H - 80,000
A - 95,000
L - 60,000
If Harper exchanges its used machine for Lubin's used machine and also receives $20,000 cash, the gain that Harper should recognize from this transaction for financial reporting purposes would be:
a) $0
b) $4,000
c) $16,000
d) $25,000

Answer 1

Harper should recognize a gain of $16,000 from the exchange of machines with Lubin. This is calculated by comparing the book value of Harper's machine ($64,000) with the fair value of the total received ($80,000). Hence, the correct answer is option (c).

Step-by-step explanation:

To calculate the gain that Harper should recognize on the exchange of machines with Lubin, we must first determine the book value of Harper's machine, which is the original cost minus accumulated depreciation.

The book value is therefore $162,500 - $98,500 = $64,000.

The fair value of Lubin's machine is given as $60,000. Harper is also receiving an additional $20,000 in cash.

The total fair value of what Harper is receiving is $60,000 (machine) + $20,000 (cash) = $80,000.

Since the exchange has commercial substance, the gain recognized would be the difference between the fair value of what is received and the book value of what is given up.

Thus, the gain would be $80,000 (total received) - $64,000 (book value) = $16,000.