for Nonmonetary Exchanges
Conceptual and Practical Implications of SFAS
James M. Fornaro, Rita J. Buttermilch, and John Biondo
- Businesses use nonmonetary exchanges for a variety of reasons.
These range from routine trade-ins of old equipment to sophisticated
exchanges of real estate. In December 2004, FASB issued SFAS 153,
Exchanges of Nonmonetary Assets, an Amendment of APB Opinion No.
29, which preserves the fundamental principle that the accounting
for nonmonetary transactions should be based on the fair values
of the assets exchanged. Accordingly, a nonmonetary asset received
in a reciprocal exchange should be recorded using the fair value
of the asset relinquished, or the value of the asset received if
it is more clearly evident.
1973, APBO 29, Accounting for Nonmonetary Transactions,
permitted an exception to this fair value principle for exchanges
involving “similar productive assets.” Such exchanges
were generally measured and recognized by reference to the book
value of the assets relinquished. SFAS 153 eliminates that exception,
but introduces a new exception for exchanges that lack “commercial
substance.” (APBO 29 also addressed other types of nonmonetary
transactions, including “nonreciprocal” transfers
with owners—e.g., dividends in-kind; or other parties—e.g.,
in-kind charitable contributions. These transactions were not
impacted by SFAS 153.) This standard was issued as part of the
short-term convergence project with the International Accounting
Standards Board (IASB). In fact, FASB largely adopted the revisions
previously made to IAS 16, Property, Plant and Equipment.
SFAS 153 requires an understanding of the term “commercial
substance” and how this concept introduces a unique element
of subjectivity to the accounting for nonmonetary transactions.
Given the lack of implementation guidance in SFAS 153, specific
illustrations are provided below and contrasted with prior practice.
The authors believe that SFAS 153 not only presents a number of
interesting and challenging issues, it also introduces elements
of professional judgment that are likely to recur in future standards.
Concepts and Changes in Practice
29 (para. 3c), an “exchange” was defined as a reciprocal
transfer whereby an entity accepts an asset or service (or satisfies
a liability) by relinquishing another asset, providing a service,
or incurring another obligation. SFAS 153 (para. 2a) amends this
definition of exchange by requiring the transferor to relinquish
the usual risks and rewards of the asset and have no “substantial
continuing involvement” therein. APBO 29 also focused on
the “attributes” of the assets exchanged (i.e., similar
or dissimilar) to determine the basis for measurement and recognition
of any associated gain or loss on the transaction. A reciprocal
exchange involving similar productive assets was generally recorded
using the book value of the transferred asset [similar productive
assets are “of the same general type, that perform the same
function or that are employed in the same line of business”
(APBO 29, par 3e)].
asserted, and FASB agreed, that assessing the “similarity”
of assets exchanged could be overly subjective and difficult to
apply in practice. This contention existed despite the exhaustive
guidance available in EITF Issues 98-3, Determining Whether
a Nonmonetary Transaction Involves Receipt of Productive Assets
or of a Business, and 01-2, Interpretations of APB Opinion No.
than 30 years, the fair value exception for similar productive
assets was supported by the following reasoning:
- The earnings
process was not complete when such exchanges transpired.
should be recognized from the sale of goods and services emanating
from the production process, not by the mere substitution of
- The entity
was often in substantially the same economic position after
- The use
of fair values could result in the arbitrary recognition of
permitted a number of nonmonetary exchanges to be recorded at
book value despite the fact that the transactions may have significantly
changed the economic position of the reporting entity. In SFAS
153, FASB concluded that the recognition and measurement principles
applicable to these transactions are better viewed by evaluating
changes to the economics of the reporting entity (commercial substance).
This approach was deemed preferable to the subjective evaluation
of the “similarity” of assets and the “timing”
of the earnings process.
is applicable to nonmonetary exchanges occurring after June 15,
2005. Certain transactions are specifically excluded from its
exchanges of assets between entities under common control;
assets (or services) acquired in exchange for the reporting
entity’s common stock;
dividends and splits;
- a transfer
of assets in exchange for an equity interest in that entity;
of financial assets; and
transactions by oil and gas producers.
also amends the scope of SFAS 140, Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities,
to include exchanges of equity-method investments for similar
deliberations over SFAS 153 (para. A20), FASB considered amending
the scope of SFAS 66, Accounting for Sales of Real Estate,
to also include exchanges of real estate. FASB later decided that
accounting guidance for reciprocal exchanges of real estate would
remain within the scope of APBO 29.
New Focus on Commercial Substance
requires that nonmonetary exchanges be recorded using the book
value of the asset relinquished (after a reduction for impairment,
if applicable) if one of the following three conditions applies:
- The fair
value of the asset relinquished or received cannot be determined
(within reasonable limits).
is an exchange of inventory for inventory that will be sold
in the same line of business to facilitate sales to customers.
- The transaction
lacks commercial substance.
two conditions are essentially unchanged from APBO 29. The third
condition replaces the prior exception for similar productive
substance” is a new concept in U.S. GAAP and presents unique,
subjective challenges for practitioners. Unfortunately, FASB did
not specifically define this term. The concept focuses on the
business purpose or rationale of the exchange, and requires an
examination of changes in the entity’s economic position
as a result of the transaction. Essentially, commercial substance
exists “if the entity’s future cash flows are expected
to significantly change as a result of the exchange” (para.
2d). FASB believes that cash flow tests provide “objective
evidence” of the business purpose of the transaction, even
though the existence of commercial substance and the underlying
assumptions are determined by its management.
substance is deemed to exist if either of the following conditions
is present (para 2d):
- The “configuration”
of the future cash flows related to the asset received is expected
to be significantly different from that of the asset transferred.
Configuration relates to the risk, timing, and amount of cash
- The “entity-specific
value” of the asset received differs from the entity-specific
value of the asset transferred, and this difference is significant
when compared to the fair values of the assets exchanged.
determination of commercial substance suggests the need for detailed
calculations, FASB indicates that a “qualitative assessment”
may be all that is required.
“entity-specific value” is relatively new to FASB
standards, though it was introduced as part of the conceptual
framework in Statement of Financial Accounting Concepts 7, Using
Cash Flow Information and Present Value in Accounting Measurements.
it represents the present value of the entity’s expected
future cash flows from the use and disposition of the asset. Entity-specific
value differs from fair value, because it reflects the entity’s
expectations as to the amounts, timing, and uncertainty of cash
flows versus those assumed by others in the marketplace.
that management should consider when determining an asset’s
entity-specific value have been broadly interpreted. These include
the manner in which the asset is integrated with the entity’s
operations as well as the synergies expected as a result of the
exchange. The minutes of FASB’s April 22, 2003, meeting
indicate that changes in entity-specific value can be assessed
“with and without the inbound asset.”
SFAS 153 Versus Prior Practice
to the exposure draft of SFAS 153 requested that FASB provide
illustrations or implementation guidance, particularly with respect
to the new commercial substance provisions. It declined, however,
to provide such guidance (para. A12) “because it believes
that the additional guidance related to commercial substance sufficiently
clarifies the meaning of that term.” FASB was also concerned
that such examples “might be viewed as bright lines”
informal discussions with practitioners and accounting educators
suggest the need for added clarity concerning the new concepts
and the subjectivity introduced in SFAS 153. Accordingly, Exhibit
1 (Trade-in of Equipment), Exhibit
2 (Exchange of Equipment), and Exhibit
3 (Exchange of Real Property) highlight key provisions in
SFAS 153 and contrast them with prior practice.
that gains and losses on exchanges of similar productive assets
are still deferred for tax purposes under IRC section 1031(a).
Accordingly, temporary differences and deferred tax consequences
will arise if commercial substance exists.
about boot? In general, SFAS 153 retains the measurement
and recognition concepts in APBO 29 in cases where boot (i.e.,
monetary consideration) is paid or received. Exhibits 1 and 2
include situations where boot is paid in an otherwise nonmonetary
exchange. The consensus in Issue 8(a) of EITF 01-02, Interpretations
of APB Opinion No. 29, also remains unchanged. In other words,
nonmonetary exchanges that involve “significant” boot,
defined as 25% or more of the fair value of the exchange, are
deemed to be monetary. Indeed, both parties should record these
exchanges at fair value and recognize all gains or losses accordingly.
SFAS 153 did not change the disclosure requirements under para.
28 of APBO 29. Accordingly, the following information regarding
nonmonetary exchanges must still be disclosed:
- The nature
of the transaction;
- The basis
of accounting for the assets transferred; and
- The amount
of gain or loss recognized during the period.
summarizes and illustrates the salient aspects of SFAS 153 and
the associated implications for accounting practice. A close examination
of the standard, however, reveals that the subjectivity inherent
in assessing commercial substance could result in inconsistent
application of SFAS 153’s provisions. FASB is expected to
use the commercial substance concept in future accounting standards.
Accordingly, the authors recommend that FASB consider providing
additional guidance on how accountants should implement this concept
in the future.
M. Fornaro, DPS, CPA, CMA, is an associate professor of
Rita J. Buttermilch, MS, CPA, is an associate professor
of accounting; and
John Biondo, MBA, CPA, PFS, is an associate professor
of accounting, all at the school of business, SUNY–College
at Old Westbury, Old Westbury, N.Y.