After many years, the Financial Accounting Standards Board (FASB) has revised the definition of a “Business.” What does that mean and why is it important? Well, in our complicated world of business transactions it is not always clear what is being purchased or sold and the definition of a business affects the accounting for recording acquisitions, disposals, goodwill and consolidation. The new standard is intended to help companies and other organizations evaluate whether transactions should be accounted for as acquisitions and disposals of assets or businesses.
The revised definition of a business will make it easier to distinguish between accounting for business combinations versus accounting for acquisitions or disposals of groups of assets, which are significantly different. Critics have long said the FASB’s current definition of a business is too broad, causing routine purchases to be treated like more complex business combinations. FASB Chairman Russell Golden said in a statement that “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. The new standard addresses this by clarifying the definition of a business while reducing the cost and complexity of analyzing these transactions.”
On January 5, 2017, the FASB published Accounting Standards Update (ASU) No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. Under this new guidance, when substantially all of the fair value of gross assets acquired is concentrated in a single asset (or group of similar assets), the assets acquired would not represent a business. The definition also introduces an initial required screen or shortcut, to help accountants make a quick call about when a set of assets is not a business. The screen requires an evaluation be made on the fair value of all the assets included in the transaction and 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.
To be considered a business, an acquisition would have to include an input and a substantive process that together significantly contribute to the ability to create outputs. The new guidance provides a framework to evaluate when an input and a substantive process are present (including for early stage companies that have not generated outputs). An output is the result of inputs and substantive processes that provide goods or services.
Although outputs are not required for a set to be a business, outputs are generally a key element of a business. Outputs are typically considered goods or services for customers, investment income or other revenues. Inputs can include people, intellectual property or raw materials. The FASB noted that outputs are a key element of a business and to be a business without outputs, there will now need to be an organized workforce.
Expected Outcome and Transition
The changes to the definition of a business will likely result in more acquisitions being accounted for as asset acquisitions across all industries, particularly real estate, pharmaceutical and oil and gas. Application of the changes would also affect the accounting for disposal transactions, which would be evaluated and recorded in the same manner and result in more asset sales. For public business entities with a calendar year-end, the standard is effective in 2018. All other entities have an additional year; however, early adoption is permitted.