HW3

Non-monetary exchanges: 

Non-monetary exchanges Homework #3

Decision tree: 

Decision tree If monetary Acquired asset at fair value, recognize all gains or losses If non-monetary If commercial substance Same If lacks commercial substance Theoretical loss Same Theoretical gain Cash received? Yes recognize a portion of the gain = cash received/boot basis of acquired asset = FV – deferred gain No recognize no gain basis of acquired asset = FV – deferred gain

HW 3: 1.1: 

HW 3: 1.1 Jayco exchanges a fleet of cars (cost, $140,000; accumulated depreciation, $60K) to Pitt Co. in exchange for land with a fair value of $160,000. Jayco also pays $50,000 to Pitt as part of the exchange. Point: Monetary exchange ($50K/$160K)

HW 3: 1.2: 

HW 3: 1.2 Assume the same facts as in 1.1 except that the fair value of the land is $110,000. Point: Gain or loss irrelevant

HW 3: 1.3: 

HW 3: 1.3 Assume the same facts as in 1.1 except that the fair value of the land is not readily determinable. Jayco also is unable to determine a reliable estimate of the fair value of the cars. They are customized vehicles designed specifically to deliver Jayco’s products. Point: But when fair value not known, record acquired asset at NBV of surrendered assets

HW 3: 1.4: 

HW 3: 1.4 Jayco trades its machine which it carries on its books at a cost of $4,000, accumulated depreciation of $1,600, for a machine with a fair value of $2,000. The machines are similar and the economic position of Jayco does not change. Point: Lacks commercial substance Theoretical loss * acquired asset at fair value * recognize the loss

HW 3: 1.5: 

HW 3: 1.5 Jayco Realty owns four acres of land, with a cost of $100,000 on the west side of the city and Kaan Realty owns three acres, with a cost of $90,000, on the east side of town. Both plots of land have a fair value of $130,000. Economic development consultants hired by both firms recommend that a strip mall be built on the east side of town and apartments catering to young adults be built on the west side of the city. Because Jayco has more experience building strip malls and Kaan has more experience building apartments, they swap plots of land. Their economic positions remain the same and there should not be a significant change in cash flows. Point: Lacks commercial substance Theoretical gain of $30K No cash received * acquired asset at book value of surrendered asset * do not recognize the gain

HW 3: 1.6: 

HW 3: 1.6 Jayco exchanges a fleet of used cars plus cash ($10,000) for land to be used as a future plant site. The cars have a cost of $70,000 and accumulated depreciation of $40,000. Jayco determines that the fair value of the cars is $35,000 and that the transaction lacks commercial substance. Point: Lacks commercial substance Theoretical gain of $5K No cash received – cash paid is irrelevant * recognize no gain * acquired asset at FV – deferred gain

HW 3: 1.7: 

HW 3: 1.7 Jayco exchanges a used machine with a carrying value of $60,000 (cost $115,000 and accumulated depreciation of $55,000) and a fair value of $100,000 for another machine with a fair value of $90,000. In addition, Jayco receives cash of $10,000. Jayco determines that the transaction lacks commercial substance. Point: Lacks commercial substance Theoretical gain of $40K Cash received * recognize a portion of the gain * acquired asset at FV – deferred gain Recognizable Gain: $10 cash recd / $100 boot = 10% 10% * $40K = $4K Asset: $90,000 - $36,000 (deferred gain)

HW 3: 1.8 Jayco sells the asset: earnings process complete: 

HW 3: 1.8 Jayco sells the asset: earnings process complete Five days after the exchange in 1.7, Jayco (unexpectedly) sells the new machine to an independent third party. The fair value of the machine has not changed, thus, the sale price is $90,000. Because the sale is unexpected, this information does not affect the assessment of the commercial substance of the original transaction. Ignore depreciation for the 5-day period. Illustrates that the deferred gain eventually gets recognized, because basis of the acquired machine is lower than it would have been. When Jayco sells the asset, it completes the earnings process.

Purchase and sale v. exchange: 

Purchase and sale v. exchange Exchange Asset #1 for Asset #2 Sell Asset #1; concurrently buy Asset #2 Exchange has commercial substance (or lacks commercial substance and a theoretical loss) Balance sheets the same Income statements the same SCF Cash paid and received in the investing section of the SCF for a purchase and sale Non-cash transaction in the footnotes for an exchange

Purchase and sale v. exchange, cont’d: 

Purchase and sale v. exchange, cont’d Exchange lacks commercial substance, theoretical gain on the exchange Income statements Full gain if a purchase and sale No gain on exchange if no cash received Less than 25% of gain on exchange if some cash received Balance sheets Purchase and sale, acquired asset at fair value Exchange: Acquired asset at fair value – deferred gain (somewhere between 75% and 100%) SCF Cash paid and received in the investing section of the SCF for a purchase and sale Non-cash transaction in the footnotes for an exchange

Provide a description of the transactions : 

Provide a description of the transactions From Mikohn’s financial statements in the 10-K for the year end 2005 In September 2005, the Company entered into separate transactions involving the licensing of intellectual property and content. The first involved the license of the Company’s legacy slot operating system of which the Company had previously acquired a portion of the rights to, made significant modifications and enhancements and obtained regulatory approval in numerous jurisdictions. We also acquired unique intellectual property content primarily for use in the Company’s server-based wagering growth initiative from this party who licensed our operating system. These transactions were accounted for as non-monetary exchanges in accordance with FASB 153 and have been recorded at cost in the accompanying consolidated balance sheets. The second transaction involved obtaining the rights to execute the license of the slot operating system from the current owner. The current owner also purchased core intellectual property from us. These transactions were recorded as non-monetary exchanges in accordance with FASB 153 and recorded at fair value in the accompanying consolidated statement of operations.

Timeline of events: 

Timeline of events Early September: Engaged in the transactions Sept 6: Forecast earnings for the quarter ended 9-30 Mikohn Gaming Corp., doing business as Progressive Gaming International Corporation, announced that it has signed a definitive agreement to acquire EndX Group Ltd. (EndX), a global gaming management systems software company headquartered in the United Kingdom for cash of $27.0 million. The Company also announced that it expects fiscal 2006 revenues, EBITDA and earnings per share to be $100 - $110 million, $32 - $35 million and $0.62 - $0.70, respectively. According to Reuters Estimates, analysts expected the Company to earn $0.64 per share on revenues of $98.1 million in the same period. Amount forecast based on improper gain recognition Investors (presumably) made investment decisions

Timeline of events, cont’d: 

Timeline of events, cont’d Oct 20: Files an 8-K to acknowledge that forecast was overstated From Mikohn’s 8-K: Prior to the end of the third quarter of 2005, per the Company’s regular policies and procedures, the Company reviewed significant transactions to determine the potential accounting treatment. Prior to entering into two complex software licensing transactions and prior to the end of the third quarter, the Company determined that it would be able to recognize approximately $6.0 million in revenue and $1.5 million of related costs. On October 19, 2005, the Company, after reviewing FASB Statement No. 153, Exchange of Non-monetary Assets—an amendment of APB Opinion No. 29, which became effective for transactions for the Company in the third quarter of 2005, and in consultation with its outside auditors, determined that it would not be able to recognize this revenue or the related costs as was previously determined prior to the end of the third quarter. Two other key dates: Oct 10: acquisition of VirtGame…suits allege they were pumping stock price until merger done January 23: Mikohn announced its agreement to acquire VirtGame (start of class period)

Price and volume activity: 

Price and volume activity