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a business transaction has commercial substance if the expected future cash flows of the business will change with the result of the transaction. A change in the cash flows is considered when there chages to one of the following:
1. Risk. An increase in the risk that the cash inflows will not occur with the business transaction.
2. Timing. A change in the time of the cash inflows received as a result of the business transaction.
3. amount. Change in the amount paid as a result of the business transaction.
a business transaction has commercial substance if the expected future cash flows of the business will change with the result of the transaction. A change in the cash flows is considered when there chages to one of the following:
1. Risk. An increase in the risk that the cash inflows will not occur with the business transaction.
2. Timing. A change in the time of the cash inflows received as a result of the business transaction.
3. amount. Change in the amount paid as a result of the business transaction.
This concept is usually used in a company when there are certain legal or accounting changes occuring, to create sham transactions to generate profits or revenues for the company. In these cases these sham transactions should not be recognized.
This is why in IAS is states that the business lacks commercial substance.
COMMERCIAL SUBSTANCE is defined as the event or transaction causing the cash flows of the entity to change. That is, if the expected cash flows after the exchange differ from what would have been expected without this occurring, the exchange has commercial substance and is to be accounted for at fair value. 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.
The economic reality that underlies a transaction or arrangement, regardless of its legal or technical denomination.
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