1) November 23, 2015
In Focus
Proposed Accounting Standards Update
Business Combinations (Topic 805): Clarifying the
Definition of a Business
On November 23, 2015, the
Financial Accounting Standards
Board (FASB) issued a proposed
Accounting Standards Update
(ASU) intended to clarify the
definition of a business, with the
objective of adding guidance that
would assist reporting organizations with evaluating whether
transactions should be accounted
for as acquisitions (or disposals)
of assets or businesses.
Stakeholders are encouraged to
review and provide comment on
the proposal by January 22, 2016
Why Is the FASB Issuing This
Proposed ASU?
The definition of a business in
Generally Accepted Accounting
Principles (GAAP) is important
because it affects many areas of
accounting, including acquisitions, disposals, goodwill, and
consolidation.
Many stakeholders have told
the FASB that the definition of
a business in Topic 805, Business Combinations, is applied
too broadly. Consequently, many
transactions qualify as business
combinations when in fact, these
stakeholders believe, they are
more akin to asset acquisitions.
Additionally, stakeholders have
said that analyzing transactions
under the current definition can
be difficult and costly. These
concerns about the definition of a
business were among the primary
issues raised in connection with
the Post-Implementation Review
(PIR) Report on FASB Statement
No. 141 (revised 2007), Business
Combinations (Statement 141),
now codified in Topic 805.
The proposed ASU seeks to address these concerns by providing a more robust framework to
determine when a set of assets
and activities is a business. The
new amendments are intended
to provide more consistency in
the application of the guidance,
reduce the costs of its application, and make the definition of a
business more operable.
How Is a Business Defined in
Current GAAP?
Current GAAP contains implementation guidance on how to
evaluate whether an acquired set
of activities and assets (collectively referred to as a “set”) is a
business. Under that implementation guidance, there are three
elements of a business: inputs,
processes, and outputs.
While a set that is a business usually will have outputs, outputs
are not required to be present.
In addition, all of the inputs and
processes that the seller uses in
operating a set are not required if
market participants are capable of
acquiring the set and continuing to
produce outputs, for example, by
integrating the set with its own inputs and processes. Current GAAP
does not specify the minimum
inputs and processes required for a
set to meet the definition of a business. That lack of clarity has led to
broad interpretations in practice of
what a business is.
Some stakeholders have said that
a set may qualify as a business
even if no processes are included
in the transaction when revenuegenerating activities continue
after an acquisition. For example,
in the real estate industry, a market participant often is capable
of acquiring inputs (a building
with leases) and combining them
with its own processes to continue generating outputs (lease
income). Other stakeholders have
said that the presence of any processes can give rise to a business,
regardless of significance.
The definition of outputs in current GAAP refers to the ability
to provide a return in the form
of dividends, lower costs, or
2) Page 2
other economic benefits directly
to investors or other owners,
members, or participants. Many
transactions can provide a return
in some form (for example, the
acquisition of a new machine
could be expected to lower costs).
Thus, the definition of outputs
contributes to broad interpretations of what meets the definition
of a business.
How Would the Proposed
Guidance Clarify the
Definition of a Business?
The proposed amendments
would require that to be considered a business, a set must include—at a minimum—an input
and a substantive process that
together contribute to the ability to create outputs, and would
remove the evaluation of whether
a market participant could replace any missing elements. The
proposed guidance also would
provide a framework to assist organizations in evaluating whether
both an input and a substantive
process are present.
In addition, the proposed guidance would include a screen
FASB In Focus
that would reduce the number
of transactions that need to be
evaluated under that framework.
When applying that screen, a set
would not be a business when
substantially all of the fair value
of the gross assets acquired is
concentrated in a single identifiable asset or group of similar
identifiable assets.
Finally, the proposed guidance
would narrow the definition of
“outputs” so that the term is
consistent with how outputs are
described in the new revenue
recognition standard.
How Does the Proposed
Amendments Compare
with International Financial
Reporting Standards (IFRS)?
The definition of a business in
GAAP currently is identical to
the definition in IFRS. However,
the Board observed that it does
not appear to be interpreted or
applied consistently in practice
between jurisdictions that apply
GAAP and those that apply IFRS.
Stakeholders have said that in
jurisdictions that apply IFRS, the
definition of a business generally
is not applied as broadly as it is in
jurisdictions that apply GAAP.
The Board’s intent is to narrow
the application of the definition
in GAAP so that practice under
GAAP and IFRS may be more
closely aligned. The IASB has
added a project on the definition
of a business to its agenda and is
considering similar amendments
to those in this proposed ASU.
When Would the Proposed
Guidance Be Effective?
The changes set forth in the
proposed ASU would be applied
prospectively to any transaction
that occurs on or after the effective date. No disclosures would
be required at transition. The
FASB will determine the effective
date and whether the proposed
changes may be applied before
the effective date after it considers stakeholder feedback.
For more information about the
project, please visit the FASB’s
website at www.fasb.org.
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The views expressed in this document do not necessarily reflect the views of the FASB. Official
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