Clarifications to definition of a business
FINANCIAL REPORTING INSIGHTS |
The definition of a business affects many areas of accounting, such as acquisitions, disposals, goodwill impairment and consolidation. However, many stakeholders believe that the current definition of a business in Accounting Standards Codification Topic 805, Business Combinations, is applied too broadly, requiring many transactions to be treated as business combinations when they should be treated as asset acquisitions. Under the current implementation guidance, there are three elements of a business — inputs, processes and outputs. While a set of assets and activities (collectively referred to as a “set”) that is a business usually has outputs, outputs are not required to be present. In addition, all the inputs and processes that a seller uses in operating a set are not required if market participants can acquire the set and continue to produce outputs.
To clarify the definition of a business, the Financial Accounting Standards Board has issued Accounting Standards Update (ASU) 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. This ASU provides a “screen” to determine when a set is not a business. The screen re¬quires that when substantially all the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This screen reduces the number of transactions that need to be further evaluated. If the screen is not met, the amendments (a) require that to be considered a business, a set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output, and (b) remove the evaluation of whether a market participant could replace missing elements. Among other amendments, the ASU also provides a framework to assist entities in evaluating whether both an input and a substantive process are present.
For public companies, the ASU is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. For all other companies and organizations, the ASU is effective for annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019. The ASU should be applied prospectively on or after the effective date. No disclosures are required at transition.
Early application of the ASU is allowed as follows:
- For transactions for which the acquisition date occurs before the issuance date or effective date of the amendments, only when the transaction has not been reported in financial statements that have been issued or made available for issuance
- For transactions in which a subsidiary is deconsolidated or a group of assets is derecognized that occur before the issuance date or effective date of the amendments, only when the transaction has not been reported in financial statements that have been issued or made available for issuance