Question

An exchange has commercial substance only if ?

Answer 1

A business transaction is said to have commercial substance when it is expected that the future cash flow of a business will change as a result of the transaction.

Therefore, if the two parties’ economic positions change, the transaction has commercial substance.

In assessing whether this has occurred, the entity has to consider if the amount, timing and uncertainty of the cash flows from the new asset are different from the one given up, or if the entity-specific portion of the company’s operations will be different. If either of these is significant, then the transaction has commercial substance.

A change in cash flows is considered when there is a considerable change in any one of the following (not including tax considerations):

• Risk - Such as experiencing an enhancement in the risk that inbound cash flows will not occur as the result of a transaction. For example, a business accepts junior secured status on a debt in exchange for a larger repayment amount.
• Timing - Such as an alteration in the timing of cash inflows received as the result of a transaction. For example, a business agrees to a delayed payment in exchange for a larger amount.
• Amount - Such as a change in the amount paid as the result of a transaction. For example, a business receives cash sooner in exchange for receiving a smaller amount.