Definition of a business gets closer to finish line

The FASB moved closer on August 24, 2016, to finalizing the definition of a business, an effort the standard-setter hopes will make it easier to distinguish between accounting for business combinations versus accounting for acquisitions of groups of assets.

The FASB’s research staff said it expected to hold one last meeting on the issue in October and then release a final update for US GAAP shortly thereafter.

The work stems from Proposed Accounting Standards Update (ASU) No. 2015-330, Business Combinations (Topic 805): Clarifying the Definition of a Business, which the board released in November.

Critics for years have said the FASB’s current definition of a business is too broad and that interpretation of the definition varies too much from industry to industry. In many cases, routine purchases have to be treated like more complex business combinations, businesses have complained.

Under the proposal, a business, at minimum, must include an input and a “substantive process” that contributes to the ability to create outputs. Outputs typically are considered goods or services for customers. Inputs can include people, money, raw materials, finished goods, and other economic resources that create, or have the ability to create, the goods or services.

The proposal also includes an initial test, or threshold, to help businesses make a quick call about whether to follow the guidance. According to this test, if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, the set would not be considered a business.

Businesses, auditors, professional groups, and analysts responding to the proposal largely agreed with its main premise. Some requested some clarifications on key terms.

The board agreed on August 24 to confirm the central theme of the proposal but to clarify what it meant by a group of “similar” assets, whether physically linked assets could be considered single assets, how to consider deferred taxes, and how to analyze goodwill.

The board agreed to retain the definition of outputs spelled out in the proposal — outputs provide or have 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.

Under the proposal, a set of assets is not considered a business if substantially all of the fair value is concentrated in a group of similar assets. The proposal does not explicitly state what “similar” means, but it indicates that assets in different asset classes could not be considered similar. It also states that tangible and intangible assets are not similar.

The FASB on August 24 agreed that it would specify that in order to be considered “similar,” the “nature, risks, and characteristics within the asset class should not be significantly different.”

Others asked the FASB for more details on what could be considered a single asset. The board agreed that in cases of a lease of a building, the lease and building would be considered a single asset.

Several comment letter writers also requested clarity about the interaction of deferred taxes and the threshold, or quick screen, to determine whether a group of assets meets the definition of a business. The FASB said that the effects of deferred tax assets should not be considered in the analysis.

The board also said that contracts cannot provide a substantive process when no outputs are present.

Finally, the board agreed that it would continue with the wording in the proposal that said the presence of more than an insignificant amount of goodwill is an indicator that a substantive process is present.

Existing GAAP for business combinations, Topic 805, Business Combinations, provides implementation guidance to determine whether a set of assets is a business. Under the guidance, a business has three elements — inputs, processes, and outputs. While a business typically will have outputs, they are not required to meet the definition of a business. In addition, the inputs and processes that the seller uses to operate are not required to be present if market participants are capable of acquiring the set of assets and continuing to produce outputs by themselves.

The FASB is tackling other, related issues — in-substance nonfinancial assets, partial sales, and retained interests — in a separate project. In June, the FASB released Proposed ASU No. 2016-250, Other Income — Gains and Losses From the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets. It covers accounting for selling or disposing of nonfinancial assets such as real estate and clarifies that an “in substance nonfinancial asset” is not “a business or nonprofit activity” or an investment held by the parent company.

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