Asset Exchange Transactions

Businesses sometimes engage in nonmonetary exchange transactions, where tangible or intangible assets are exchanged for other assets, without a cash transaction or with only a small amount of cash “settle up”. These exchanges can involve productive assets such as machinery and equipment, which are not held for sale under normal circumstances, or inventory items, which are intended for sale to customers.

IAS 16 Property, Plant and Equipment (PPE) provides authoritative guidance to the accounting for nonmonetary exchanges of tangible assets. It states that “an entity is required to measure an item of property, plant and equipment acquired in exchange for a non-monetary asset or assets, or a combination of monetary and non-monetary assets, at fair value unless the exchange transaction lacks commercial substance”.

The concept of  a purely “book value” exchange, as formerly employed in previous version of IAS 16, is now prohibited under most circumstances.

Paragraph 22 of the previous version of IAS 16 indicated that if (a) an item of PPE is acquired in exchange for a similar asset that has a similar use in the same line of business and has a similar fair value or (b) an item of PPE is sold in exchange for an equity interest in a similar asset, then no gain or loss is recognized on the transaction. The cost of the new asset is the carrying amount of the asset given up (rather than the fair value of the purchase consideration given for the new asset).

This requirement in the previous version of IAS 16 was consistent with views that :

1. gains should not be recognized on exchange of assets unless the exchanges represent the culmination of an earning process;
2. exchanges of assets of a similar nature and value are not a substantive event warranting the recognition of gains; and
3. requiring or permitting the recognition of gains from such exchanges enables entities to ‘manufacture’ gains by attributing inflated values to the assets exchanged, if the assets do not have observable market price in active markets.

Commercial Substance

Commercial substance is a new notion under IFRS, and 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.

If the transaction does not have commercial substance, or the fair value of neither the asset received nor the asset given up can be measured reliably, then the asset acquired is valued a the carrying amount of the asset given up. Such situations are expected to be rare (Hrd).

(Sources : Wiley IFRS 2008 : Interpretation and Application of International Financial Reporting Standards - Barry J. Epstein, Eva K. Jermakowicz and IAS 16 Property, Plant and Equipment)