In an effort to improve financial reporting of acquisitions of nonfinancial assets, the Financial Accounting Standards Board (FASB) issued a proposed Accounting Standards Update on Nov. 23 that focuses on clarifying the definition of a business.
This guidance would help organizations determine whether transactions should be accounted for as acquisitions of assets or businesses.
The comment period for the proposed Accounting Standards Update, Business Combinations (Topic 805): Clarifying the Definition of a Business, concludes on Jan. 22, 2016. Instructions on how to submit comments are included in the exposure draft.
The current definition of a business under US GAAP affects such areas of accounting as acquisitions, disposals, goodwill, and consolidation. But the FASB has received feedback from stakeholders that the definition of a business in Topic 805, Business Combinations, is applied too broadly. As a result, many transactions qualify as business combinations when they should be treated as asset acquisitions.
Stakeholders also said that analyzing transactions under the current definition of a business can be costly and complex. These concerns were also raised in connection with the Post-Implementation Review Report on FASB Statement No. 141 (revised 2007), Business Combinations (Statement 141), now codified in Topic 805.
Under the current implementation guidance, there are three elements of a business: inputs, processes, and outputs. While a set of assets and activities that is a business usually will have outputs, outputs are not required to be present. All of the inputs and processes that a seller uses in operating a set of assets and activities are not required if market participants are capable of acquiring the set and continuing to produce outputs. Current accounting rules do not specify the minimum inputs and processes required for a set of assets and activities to meet the definition of a business, which has led to broad interpretations in practice of what a business is, according to the FASB.
In addition, some stakeholders noted that a set of assets and activities may qualify as a business even if no processes are included in the transaction when revenue-generating activities continue after an acquisition. For example, in the real-estate industry, a market participant often is capable of acquiring inputs, such as a building with leases, and combining them with its own processes to continue generating outputs (lease income).
Finally, under current GAAP, the definition of outputs refers to 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 â which can also contribute to broad interpretations of the definition of a business.
The guidance in the proposed Accounting Standards Update would address these concerns by providing a framework for determining when a set of assets and activities is a business. The proposed standard would clarify the definition of a business in the following three ways:
- Require that to be considered a business, a set must include â at a minimum â an input and a substantive process that together contributes to the ability to create outputs, and would remove the evaluation of whether a market participant could replace any missing elements. It would also assist organizations in evaluating whether both an input and a substantive process are present.
- Include a screen that would reduce the number of transactions that need to be evaluated under that framework. When applying that screen, a set of assets and activities would not be a business when substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets.
- Narrow the definition of outputs so that the term is consistent with how outputs are described in the new revenue recognition standard.