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A nonmonetary exchange has commercial substance if the entity’s future cash flows are expected to significantly change as a result of the exchange. A significant change is characterized by either of the following:
1.
The configuration (i.e., risk, timing and amount) of the future cash flows of the asset(s) received differ significantly from the configuration of the future cash flows of the asset(s) transferred.
2.
The entity-specific value of the asset(s) received differs from the entity-specific value of the asset(s) transferred, and the difference is significant in relation to the fair values of the asset(s) exchanged.
When evaluating whether the configuration of cash flows has significantly changed, an entity should evaluate the amount and timing of the expected gross cash flows of the asset(s) to be received and the risks specific to those cash flows. If any of those factors, alone or in combination, significantly differs from the nature of the future cash flows of the asset(s) to be transferred, there is commercial substance and the exchange should be measured at fair value.
Further, when evaluating the entity specific value of the asset(s) exchanged, it is important to note that the entity specific value is not necessarily fair value as defined by ASC 820. Rather, an entity specific value considers and incorporates how the asset is expected to be used by the particular entity rather than by a market participant.
ASC 845 does not provide any bright line tests or quantitative guidance on what is considered significant for purposes of the commercial substance test. Judgment must be used to determine significance. The standard indicates that in some cases a qualitative assessment will be conclusive in determining that an entity’s cash flows are expected to significantly change as a result of the exchange. We believe that most commercial substance assessments will focus on the degree to which the asset(s) specific cash flows or entity specific asset values are expected to change as a result of the exchange. The FASB’s view that most exchanges will be accounted for at fair value and the inclusion of the qualitative assessment description in ASC 845-10-30-4 appear to reflect this and suggest that the significance of cash flow changes, and therefore the commercial substance of an exchange, should be fairly obvious.
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