The FASB on Jan. 5, 2017, published Accounting Standards Update (ASU) No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, to clear up the guidance for determining whether the purchase or sale of an asset or group of assets qualifies as the purchase or disposal of a business.
The revision of the definition of “business” in the Accounting Standards Codification is expected to reduce the number of transactions that qualify as business combinations versus routine deals involving assets. Public companies must follow the new guidance for annual periods beginning after Dec. 15, including interim periods within those fiscal years. Privately held companies and other organizations must adhere to the new definition for fiscal years beginning after Dec. 15, 2018, and interim periods within fiscal years that begin after Dec. 15, 2019.
Critics have long complained that the current definition of a business is overly broad and captures too many day-to-day purchases of assets, requiring businesses to follow U.S. GAAP’s relatively more complex rules for business combinations.
“Stakeholders expressed concerns that the definition of a business is applied too broadly and that many transactions recorded as business acquisitions are, in fact, more akin to asset acquisitions,” FASB Chairman Russell Golden said in a statement. “The new standard addresses this by clarifying the definition of a business while reducing the cost and complexity of analyzing these transactions.”
The update lays out new minimum requirements for a set of assets to be considered a business. A set must, at minimum, include an “input” and a substantive process that together significantly contribute to create outputs. The standard provides guidance to determine whether both an input and a substantive process are present. It also includes two sets of criteria to consider whether a set has outputs.
Although outputs are not required for a set to be a business, outputs generally are a key element of a business, the FASB said. Outputs typically are considered goods or services for customers, investment income, or other revenues. Inputs can include people, intellectual property, or raw materials.
The update also provides a screen, or shortcut, to help accountants make a quick call about when a set of assets is not a business. The screen requires that when substantially all the fair value of the gross assets acquired or disposed of is concentrated in a single asset or a group of similar identifiable assets, the set is not a business.
The new definition is based on a proposal the FASB released in November 2015 as Proposed ASU No. 2015-330, Business Combinations (Topic 805): Clarifying the Definition of a Business.
The update is considered phase one of the FASB’s broader effort sharpen the difference between the acquisition or sale of a business and the acquisition or sale of a group of assets.
In June, the FASB released what it considers phase two, via 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, to clarify how to account for sales and disposals of nonfinancial assets like real estate.
The planned amendments would typically apply to contracts “in which substantially all of the fair value of the assets promised to a counterparty is concentrated in nonfinancial assets” and subsidiaries “in which substantially all of the fair value of the assets in the subsidiary is concentrated in nonfinancial assets.” The FASB expects to publish a final update to U.S. GAAP in the coming months.
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