In response to concerns that its current definition of a business is overly broad and tough to apply, the Financial Accounting Standards Board (FASB) issued a new standard on Jan. 5 that provides more guidance.
The new standard is intended to assist companies and other organizations with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses.
The current definition of a business under US GAAP affects such areas of accounting as acquisitions, disposals, goodwill, and consolidation. But stakeholders told the FASB that the definition of a business in Topic 805, Business Combinations, is applied too broadly. As a result, many transactions qualified as business combinations when they should have been treated as asset acquisitions.
“The new standard addresses this by clarifying the definition of a business while reducing the cost and complexity of analyzing these transactions,” FASB Chairman Russell Golden said in a written statement.
Accounting Standards Update (ASU) No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, includes amendments to Topic 805 that provide a screen to determine when a set (an integrated set of assets and activities) is not a business.
The screen requires that when substantially all of the fair value of the acquired or disposed of gross assets is concentrated in one identifiable asset or a group of similar identifiable assets, the set is not a business. That reduces the number of transactions that require further evaluation.
If the screen is not met, the amendments require:
- To be a business, a set must include at least an input and a substantive process that together contribute to the ability to create output.
- Removal of the evaluation of whether a market participant could replace missing elements.
The new standard provides a framework that helps companies evaluate whether input and a substantive process are both present. The framework includes criteria for consideration that depend on whether a set has outputs. While outputs aren’t required for a set to be considered a business, they generally are a key business element. Because of that, the FASB developed tougher criteria for sets without outputs.
The amendments also more narrowly define “output” so that it’s consistent with how outputs are described in the new revenue recognition standard.
The ASU also addresses questions raised about the interaction of the definition of a business and the term “in substance nonfinancial asset” as it is used in Subtopic 610-20, Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets, which was created as part of the amendments in ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606).
Until the amendments in the revenue recognition standard take effect, the derecognition of real estate should be accounted for consistently, whether or not the real estate is an asset or a business, according to the FASB. The amendments in ASU 2014-09 remove real estate-specific guidance so that, for purposes of determining what derecognition model to apply in sales transactions with noncustomers, an entity must determine whether a real estate transaction is a sale of a business or of a nonfinancial asset (or an in substance nonfinancial asset).
The FASB expects to issue another ASU soon that will clarify guidance for partial sales or transfers of assets within Subtopic 610-20 and the accounting for retained interests. The board states it will clarify the reference to “in substance nonfinancial assets.” The FASB also plans to consider whether differences in the acquisition and derecognition guidance for assets and businesses could be aligned.
The new standard affects all companies and other reporting organizations that must determine whether they have acquired or sold a business. For public companies, the standard takes effect for annual periods beginning after Dec. 15, 2017, including interim periods within those periods. For all other companies and organizations, the standard goes into effect for annual periods beginning after Dec. 15, 2018, and interim periods within annual periods beginning after Dec. 15, 2019.
The amendments should be applied prospectively on or after the effective dates. No disclosures are required at transition, the FASB said.