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Wednesday, October 19, 2016

When a Group of Assets Becomes a Business

What is a business? This may seem like a fundamental question, but the Financial Accounting Standards Board (FASB) has been debating how to differentiate the purchase of a business from the purchase of a group of assets for several years.

In November 2015, the FASB issued a proposal to help financial executives and accountants define what a business is in the context of a business combination. Here’s more on the status of this proposal, including highlights and feedback from businesses, auditors and professional groups.

Existing Rules
Business owners and managers generally know the difference between a business and a group of assets. But in some instances—such as a merger or an acquisition—the distinction is unclear. So, the FASB wants to provide clearer guidance to help financial officers and accountants decide.

In Topic 805, Business Combinations, U.S. Generally Accepted Accounting Principles (GAAP) provides implementation guidance to determine whether a set of assets is a business. Under the guidance, a business has three elements:

  1. Inputs,
  2. Processes, and
  3. Outputs.

While a business typically will have outputs, outputs aren’t required to meet the definition of a business. In addition, the inputs and processes that the seller uses to operate aren’t required to be present if market participants are capable of acquiring the set of assets and continuing to produce outputs by themselves.

There are no minimum inputs and outputs required to meet the definition of a business, and the lack of clarity has led to broad interpretations. Critics also have said that, in many cases, routine purchases must be treated like complex business combinations under existing GAAP.

Proposed Clarity
In November 2015, the FASB issued a proposal to clarify the definition of a business under GAAP. The proposal provides guidance in how to account for a business combination as opposed to a routine purchase of goods or services.

According to Proposed Accounting Standards Update (ASU) No. 2015-330, Business Combinations (Topic 805): Clarifying the Definition of a Business, 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) goods or services.

The proposal includes an initial test to help businesses make a quick decision about following 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 asset wouldn’t be considered a business.

Mixed Feedback
In July, the FASB started reviewing public feedback to its proposal. Comment letters from businesses, auditors and professional groups largely supported the proposal. Some comment letters requested clarification, however. Specifically, they asked the FASB 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. Here are more details:

Similar assets. Under the proposal, a set of assets isn’t considered a business if substantially all of the fair value is concentrated in a group of similar assets. The proposal doesn’t explicitly state what “similar” means, but it indicates that assets in different asset classes couldn’t be considered similar. It also states that tangible and intangible assets aren’t similar. In August, the FASB decided that, in order to be considered similar, the “nature, risks, and characteristics within the asset class should not be significantly different.”

Single asset. The board has agreed that, in cases of a lease of a building, the lease and building should be considered a single asset.

Deferred taxes. Several comment letters requested clarity about the interaction of deferred taxes and the initial test to determine whether a group of assets meets the definition of a business. The FASB decided that the effects of deferred tax assets should not be considered in the analysis.

Goodwill. The board agreed that it would maintain the wording in the proposal that says the presence of more than an insignificant amount of goodwill is an indicator that a substantive process is present.

Finally, the FASB decided 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.

Stay Tuned
The FASB plans to meet again in October to iron out the final details and weigh additional public comments. Then it plans to issue a final ASU before year end to help business owners report purchases of assets and businesses with greater confidence and certainty.

Spotlight on a Related Proposal

The Financial Accounting Standards Board (FASB) is addressing other issues related to the definition of a business, such as in-substance nonfinancial assets, partial sales and retained interests. In June, the board issued Proposed Accounting Standards Update (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.

The updated guidance covers accounting for the sale or disposal of nonfinancial assets, such as real estate. It also clarifies that an “in-substance nonfinancial asset” is not “a business or nonprofit activity” or an investment held by the parent company.

Comments on this proposal were due in August. The FASB plans to incorporate the feedback on this related proposal into its final ASU on the definition of a business. 


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