When future changes to a company's cash flows are anticipated as a result of a business transaction, that transaction is said to have "commercial substance."
What is Commercial Substance?
- Any significant change in any one of the following (excluding tax considerations) is deemed to indicate a change in cash flows.
- Risk : When there is risk, a transaction can have commercial substance, such as when the possibility that inbound cash flows won't happen as a result of a transaction increases. For instance, a company might agree to a debt's junior secured status in exchange for a bigger repayment sum.
- Timing : Depending on how a transaction is timed, it may or may not have commercial significance. One example of this is when the timing of cash inflows that are received as a result of a transaction is altered. A company might consent to a postponed payment in exchange for a higher sum, for instance.
- Amount : Any change in the amount paid as a result of a transaction, for example, qualifies as a transaction with commercial substance. In exchange for obtaining a smaller sum of money, for instance, a business obtains cash more quickly.
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