Heads Up — FASB proposes amendments to clarify the definition of a business
On November 23, 2015, the FASB issued a proposed ASU that would clarify the definition of a business in ASC 805 and provide a framework that an entity can use to determine whether a set of activities and assets (collectively, a “set”) constitutes a business.
The FASB issued the proposed ASU in response to stakeholder feedback indicating that the definition of a business in ASC 805 is too broad and that too many transactions are qualifying as business combinations even though many of these transactions may more closely resemble asset acquisitions. Because the current definition has been interpreted broadly, it can be inefficient and costly to analyze transactions and entities may not be able to use “reasonable judgment.” The proposed amendments would make application of the guidance more consistent and cost-efficient.
Editor’s Note: Concerns about the definition of a business were among the primary issues raised in connection with the FAF’s post-implementation review report on FASB Statement No. 141(R), Business Combinations (codified in ASC 805).
Significance of the Proposal
An entity uses the definition of a business in ASC 805 in determining whether to account for a transaction as an asset acquisition or a business combination. This distinction is important because the accounting for an asset acquisition significantly differs from the accounting for a business combination. For example, the acquirer’s transaction costs are capitalized in an asset acquisition but are expensed in a business combination. Another difference is that in a business combination, the assets acquired are recognized at fair value and goodwill is recognized; in an asset acquisition, however, the cost of the acquisition is allocated to the assets acquired on a relative fair value basis and no goodwill is recognized.
The FASB considered addressing the concern about the definition of a business more directly by attempting to reduce or eliminate differences between the accounting for business combinations and that for asset acquisitions. However, to respond to stakeholder concerns in a timely fashion, the FASB decided to begin this project by clarifying the definition of a business.
Editor’s Note: The definition of a business in ASC 805 also affects other aspects of accounting such as disposal transactions, determining reporting units, and the business scope exception in ASC 810. The proposed amendments would cause fewer sets of assets (and liabilities) to be identified as businesses.
Challenges Related to Applying the Current Definition of a Business
The definition of a business would remain unchanged under the proposed ASU. ASC 805 defines a business as:
An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants.
The current implementation guidance in ASC 805-10-55-4 states that a “business consists of inputs and processes applied to those inputs that have the ability to create outputs.” A business has three elements — inputs, processes, and outputs. All businesses have inputs and processes, and most have outputs, but outputs are not required for a set to be a business. Further, ASC 805-10-55-5 states that “all of the inputs or processes that the seller used” in operating the set do not need to be part of the transaction “if market participants are capable of acquiring the [set] and continuing to produce outputs, for example, by integrating the [acquired set] with their own inputs and processes.”
The current implementation guidance does not specify the minimum inputs and processes required for a set to meet the definition of a business, which has led some to interpret the definition of a business broadly. Some have said that a set may qualify as a business even if no processes are acquired when revenue-generating activities continue after an acquisition or if a market participant would be capable of integrating the acquired set with its own processes. For example, some believe that the acquisition of real estate with an in-place lease meets the definition of a business because a market participant is capable of acquiring an input (a building with a lease) and combining it with its own processes (processes to collect rent and maintain the building) to continue generating outputs (rental income). Others have said that the presence of any process can give rise to a business, regardless of the significance of that process.
In addition, ASC 805-10-55-4(c) refers to an output as having “the ability to provide a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants” (emphasis added). Many transactions can provide a return in some form (e.g., the acquisition of a new machine might lower costs). Thus, the definition of outputs has further contributed to broad interpretations of the definition of a business.
Main Provisions of the Proposal
The proposed ASU’s Basis for Conclusions indicates that the amendments would “narrow the definition of a business and provide a framework that gives entities a basis for making reasonable judgements about whether a transaction involves an asset or a business.” In addition, the proposal provides examples illustrating the application of the amendments to the determination of whether a set is a business.
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