by A nonmonetary exchange is the transfer of assets and/or liabilities with another entity. The most common situation is when two organizations exchange assets, such as a real estate swap or the exchange of one fixed asset for another. The accounting for a nonmonetary exchange is based on the fair values of the assets transferred. This results in the following set of alternatives for determining the recorded cost of a nonmonetary asset acquired in an exchange, in declining order of preference:
- At the fair value of the asset received, if the fair value of this asset is more evident than the fair value of the asset transferred in exchange for it.
- At the fair value of the asset transferred in exchange for it. Record a gain or loss on the exchange.
- At the recorded amount of the surrendered asset, if no fair values are determinable or the transaction has no commercial substance.
Types of Non-Monetary transactions
The following are the types of non-monetary transactions.
- Non-reciprocal transfers with nonowners such as charitable donation of property by an entity, land contribution by state or local governments to a private enterprise for the purpose of setting up a structure.
- Non-reciprocal transfer to owners such as stock split, exchange of non-monetary assets for common stock.
- Non-monetary exchanges such as inventory exchange for a similar product or any productive asset. Or exchange of productive assets.
Accounting for an Exchange of Nonmonetary Assets
There can be any number of variations on the nonmonetary exchange concept, including ones where some cash is exchanged, along with other nonmonetary assets. If there is a significant amount of monetary consideration paid (known as boot), the entire transaction is considered to be a monetary transaction. In GAAP, a significant amount of boot is considered to be 25% of the fair value of an exchange. Conversely, if the amount of boot is less than 25%, the following accounting applies:
Payer. The party paying boot is not allowed to recognize a gain on the transaction.
Recipient. The receiver of the boot recognizes a gain to the extent that the monetary consideration is greater than a proportionate share of the carrying amount of the surrendered asset. This calculation is based on the percentage of monetary consideration received to either:
- The fair value of the nonmonetary asset received.
- Total consideration received
- Nonmonetary exchanges of inventory should be recognized at the carrying amount of the inventory transferred.
Exchanges with commercial substance
A business transaction is said to have commercial substance when it is expected that the future cash flows of a business will change as a result of the transaction. A change in cash flows is considered to be when there is a significant change in any one of the following:
- Such as a change 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.
- Such as experiencing an increase 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.
- 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.
A contract is said to have the commercial substance if because of that contract there is a change in timing of cash flow, there is an increment in the cash flow, there is a change in the risk, or more benefits occur due to contract.
For example, A Ltd entered into a contract with ABX and Co. who is a major supplier of raw material required by A Ltd. for production of goods for supplying materials to A ltd.at a cost lower than the cost at which A Ltd. was buying from other suppliers, and because of it, the cost of production is decreased as a result the benefits will also be transferred to the customers by decreasing the selling price which thereby results in the increase in revenue. In this whole scenario, since there is a change in cash flow, it is said to have existed in the contract.
The concept of commercial substance is also applied to exchanges of assets between businesses. When there is commercial substance (which is when there is a change in cash flow resulting from the transaction), the parties should recognize a gain or loss on the exchange. If there is no commercial substance, record the acquired asset at the book value of the asset given up in the exchange. There are additional issues related to the recognition of a gain or loss when a transaction has no commercial substance.
Exchanges without commercial substance
situations where there is no commercial substance include:
- The swapping of bandwidth capacity by different Internet and phone service providers. By doing so, both entities recognize revenue, when in fact no real revenue generation occurs that would result in a change in profits.
- Sale of assets to the owner of a sole proprietorship, who immediately leases it back to the business. There is little distinction between a proprietorship and its owner, so it is likely that no real change of ownership occurred.
