Changes to the definition of a business could bring significant changes to accounting for acquisitions, divestitures, consolidations, and segment changes. Accounting Standards Update 2017-01, Business Combinations (Topic 805), Clarifying the Definition of a Business (ASU 2017-01) creates a framework that may result in fewer complex transactions qualifying as business acquisitions for accounting purposes. Transactions that did not meet the definition in ASC Topic 805 will be accounted for as asset acquisitions.
Public companies will be adopting in the 2018 calendar year—the guidance is required for financial statements issued for fiscal years beginning after Dec. 15, 2017, and interim periods within those fiscal years. Nonpublic business entities are required to adopt in the 2019 calendar year (for financial statements beginning after Dec. 15, 2018, and interim periods within fiscal years beginning after Dec. 15, 2019) and may want to consider early adoption depending on their facts and circumstances.
In current U.S. GAAP, there are three elements related to a business: inputs, processes, and outputs. Actual outputs are not considered necessary to meet the definition of a business. An entity is required to assess whether the acquired assets and activities are capable of being managed as a business. If certain inputs and/or processes are missing at the time of acquisition, the transactions can still be accounted for as the acquisition of a business as long as the needed inputs/processes are available to the hypothetical market participant. The ASU 2017-01 framework adds an initial "screen" to the definition of a business to determine if substantially all of the fair value of the gross assets acquired is concentrated in a single asset or group of similar assets. If that is the case (i.e., the screen is met), the set of assets and activities acquired is not considered a business. The framework also specifies the minimum required inputs and processes necessary to be considered a business. Additionally, the acquirer no longer must consider the market participant's ability to provide inputs or processes that were not acquired as part of the acquisition when evaluating whether all of the input and processes necessary to produce outputs were obtained.
ASU 2017-01 retains what currently qualifies as an "input" and "process," however; it also clarifies that the intellectual capacity of an organized workforce could also qualify as a process. Finally, the new guidance provides a narrower definition of an "output" and harmonizes it with how it is described in ASC Topic 606, Revenue from Contracts with Customers.
Acquisitions that do not meet the standard will be considered asset acquisitions and come with different accounting considerations than business combinations:
- Goodwill or gain is not recognized
- Transaction costs are capitalized
- If involving a workforce, the intangible asset of the workforce is allocated a portion of the cost
Additionally, the new definition may change whether an organization is able to meet the business scope exception in ASC Topic 810, Consolidation.
Why Private Entities May Consider Early Adoption
There are a variety of judgments across several subjects that will need to be made upon adoption. Entities considering an early adoption should familiarize themselves with the new framework and discuss the impact of the new guidance with their business advisors, accountants, and auditors. The adoption of ASU 2017-01 will require careful consideration of facts and circumstances surrounding acquisition transactions. If private entities elect to early adopt, they can do so on a prospective basis.
For More Information
If you have questions about the definition of a business, contact James Comito of MHM's Professional Standards Group. James can be reached at firstname.lastname@example.org.
Published on March 20, 2018