Definition of a business
Definition of a business — Cover note — Agenda paper 13
Background
The IASB discussed the feedback received on the Exposure Draft Definition of a Business and Accounting for Previously Held Interests (ED/2016/1) in its April and June 2017 meetings. Based on the feedback received, the IASB reached various tentative decisions that differ from the FASB’s related amendments (‘FASB Amendments’). In this session, the Staff:
- summarised the main differences between the two Boards’ decisions and provided feedback from the Accounting Standards Advisory Forum (ASAF) members on the IASB’s tentative decisions (AP 13A); and
- sought the IASB’s permission to ballot the amendments (AP 13C).
AP 13B contains a summary of the IASB’s tentative decisions to date.
Definition of a business — Comparison between FASB Amendments and IASB tentative decisions — Agenda Paper 13A
Background
Apart from the optional nature of the screening test (see point 1 below), the ASAF members generally agreed with all of the IASB’s tentative decisions. The Staff did not provide any effect analysis on the inconsistencies identified below.
Staff analysis
1. The screening test
The IASB tentatively decided to make the screening test optional and determinative. This means that entities can choose to apply the screening test on a transaction-by-transaction basis but the outcome of the test regarding whether the entity has acquired a business or a group of assets is conclusive. The FASB Amendments’ screening test is mandatory and determinative.
Some ASAF members were concerned that having an optional test would open up structuring opportunities to entities to apply the test only if it results in a desired outcome. The Staff acknowledged their concern and analysed some alternatives suggested by the ASAF members, including making the test mandatory, using it as an indicator or a rebuttable presumption, or removing the test. These alternatives are similar to those suggested by the respondents to the ED and have been deliberated by the IASB in its April 2017 meeting. On balance, the Staff continued to believe that it is most appropriate to make the test optional and determinative. They believed that the risks arising from structuring opportunities are limited because in most cases the screening test and the guidance on substantive process are expected to lead to the same outcome.
With regard to what constitutes gross assets for the purpose of the screening test, the FASB Amendments exclude cash and cash equivalents from this term. The IASB has not discussed this issue previously. The Staff recommended that the IASB provide the same exclusion on grounds that cash acquired does not have any relation to whether there is a business combination or an asset purchase. Furthermore, including cash in gross assets might inadvertently cause an asset acquisition to fail the screening test, e.g. if the gross assets acquired include significant cash balances.
2. Definition of output
The IASB tentatively decided to clarify that:
- ‘other revenues’ means other income arising from contracts that are within the entity’s ordinary activities but are outside the scope of IFRS 15; and
- if an acquired set of assets generated revenues before the acquisition, but is integrated by the acquirer and no longer generates revenues after the acquisition, that set of assets is regarded as creating outputs.
The FASB Amendments do not explain the meaning of other revenues. However, the Staff believed that the proposed description above is consistent with the FASB Amendments because the latter’s Basis for Conclusions refers to revenue streams that are not included within the scope of Topic 606 (the FASB’s equivalent of IFRS 15).
Point b) above is inconsistent with the FASB Amendments, which require a continuation of revenue before and after the transaction for the acquired set of assets to be considered as being capable of creating outputs.
3. Definition of a business and definition of output
The IASB’s proposed definition of a business is aligned with the definition of output. In contrast, there is no specific alignment between these two terms under the FASB Amendments. However, the FASB Amendments’ definition of a business indirectly refers to the definition of output.
4. Guidance on acquired outsourcing agreements
The IASB tentatively decided to confirm that an outsourced workforce may perform a substantive process even if the acquired set of assets has no output. In contrast, the FASB decided that when outputs are not present, the acquired set of assets would need to include an organised workforce that is made up of employees.
5. Goodwill
The IASB tentatively decided not to include a statement in IFRS 3 that the presence of more than an insignificant amount of goodwill may be an indicator that an acquired process is substantive and, therefore, the acquired set is a business. This was done to remove any circular application of the guidance and confusion. However, the FASB Amendments contain an explicit statement to this effect. The Staff did not believe that this would result in significant divergence in practice this guidance is intended to be an indicator and is not determinative.
6. Difficulties in replacing an acquired workforce may indicate that the workforce performs a substantive process
The IASB proposed to specify that difficulties in replacing an acquired workforce may indicate that the workforce performs a substantive process. There is no such explicit statement in the FASB Amendments.
7. Oil and Gas Illustrative Example
The IASB tentatively decided to retain an example that illustrates whether an acquired set of assets is a business when no workforce is acquired. This example relates to the oil and gas industry and was deleted by the FASB when finalising its Amendments on grounds that the example would become too technical if the FASB were to address the concerns raised by their respondents.
The Staff continued to believe it beneficial to retain the example because it illustrates the concept of ‘a process that cannot be replaced without significant cost, effort, or delay in the ability to continue producing outputs is a substantive process’.
Staff recommendation
In light of the above, the Staff recommended that the IASB:
- confirm its previous tentative decisions;
- retain Example J (see point 7 above), but clarifying in the fact pattern that the processes acquired are difficult to replace; and
- exclude cash and cash equivalents from the gross assets acquired for the purpose of applying the screening test.
Discussion
The Board approved recommendations (a) and (c) but decided to remove Example J from the amendments.
Several Board members were confused about what is meant by an optional and determinative screening test. They agreed with and understood the Staff’s clarification in paragraph 22 of the paper, and asked the Staff to replace the term ‘determinative’ with ‘no further assessment is needed’. One Board member suggested explaining the reason for the inconsistency with the FASB’s ‘mandatory and determinative’ requirements in the Basis for Conclusion (too many instances were identified as business combinations under US GAAP; however, the IASB’s constituents did not identify this as an issue under IFRS).
As for the oil and gas example, the Board members saw no compelling reason to keep it given that respondents with significant experience in oil and gas operations had raised substantive comments about it, and that the FASB had removed this example from their final amendments.
Definition of a business — Due process followed — Agenda Paper 13C
Staff recommendation
The Staff asked the Board for permission to ballot without re-exposure.
The Staff further recommended that the amendments to IFRS 3 be effective for business combinations with an acquisition date that is on or after the start of annual reporting periods beginning on or after 1 January 2020, with earlier application permitted.
Next steps
The Staff plan to start the balloting process in November 2017 and expect to issue the amendments in the first half of 2018.
Discussion
The Board unanimously approved the Staff’s recommendation.
