When common stock is issued in exchange for a noncash asset, the transaction should be recorded at
A. the par value of the stock issued
B. the fair market value of the stock
C. the fair market value of the asset acquired
D. the fair market value of the asset acquired or the fair market value of the stock, whichever can be determined more objectively.
The correct answer and explanation is :
The correct answer is:
D. The fair market value of the asset acquired or the fair market value of the stock, whichever can be determined more objectively.
Explanation:
When a company issues common stock in exchange for a noncash asset, the accounting principle of cost measurement applies. The transaction should be recorded based on the most reliable and objective valuation to ensure accurate financial reporting.
1. Fair Market Value Basis
Accounting standards require that such transactions be recorded at fair market value, but the challenge is determining whether the stock’s market value or the asset’s market value is more reliable. The guiding principle is to use the value that is more clearly determinable and objectively measurable.
2. Determining the More Objective Fair Market Value
- If the stock is actively traded on a public exchange, its market price is readily available and serves as a reliable measure of fair value. In such cases, the fair market value of the stock should be used to record the transaction.
- If the stock is not actively traded, or if its market price is volatile or difficult to determine, then the fair value of the asset acquired should be used instead. This is often assessed through independent appraisals, market comparisons, or recent purchase transactions.
3. Avoiding Arbitrary Valuations
Using the more objective fair value ensures that financial statements reflect economic reality and prevent management from arbitrarily inflating or deflating the value of transactions. The approach also aligns with Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), which emphasize reliability and relevance in financial reporting.
Thus, companies should always choose the most objectively determinable fair value—whether it is the stock or the asset—to ensure proper financial reporting.