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Journal entry — FASB makes tentative decisions related to clarifying the definition of a business

Published on: Dec 18, 2014

At its meeting this week, the FASB made tentative decisions related to its project on the definition of a business.

ASC 805-10-55-41 provides the following implementation guidance to help entities identify what constitutes a business:

A business consists of inputs and processes applied to those inputs that have the ability to create outputs. Although businesses usually have outputs, outputs are not required for an integrated set to qualify as a business. The three elements of a business are defined as follows:

a. Input. Any economic resource that creates, or has the ability to create, outputs when one or more processes are applied to it. Examples include long-lived assets (including intangible assets or rights to use long-lived assets), intellectual property, the ability to obtain access to necessary materials or rights, and employees.

b. Process. Any system, standard, protocol, convention, or rule that when applied to an input or inputs, creates or has the ability to create outputs. Examples include strategic management processes, operational processes, and resource management processes. These processes typically are documented, but an organized workforce having the necessary skills and experience following rules and conventions may provide the necessary processes that are capable of being applied to inputs to create outputs. Accounting, billing, payroll, and other administrative systems typically are not processes used to create outputs.

c.  Output. The result of inputs and processes applied to those inputs that provide or have the ability to provide a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants.

As the FASB staff explained in the meeting handout, many stakeholders encounter complexities in “identifying and evaluating the processes that must be included in [a] transaction” when determining whether an acquisition constitutes a business combination or an asset acquisition. The FASB therefore decided to continue to explore what processes must be included in a transaction and tentatively decided “that a business must include inputs and one or more substantive processes that together contribute to the creation of outputs.”

The staff also noted that the “definition of a business in Issue 98-3[2] allowed for a transferred set of activities to be [considered] an asset [acquisition] if all but a de minimis amount (which the guidance indicated was 3 percent) of the fair value was represented by a single tangible or identifiable, intangible asset.” ASC 805 nullified the definition in Issue 98-3 and significantly broadened what is now considered a business. The staff’s outreach revealed that incorporating a threshold into the definition of a business would reduce complexity in an entity’s assessment of acquisitions that have relatively few inputs and processes. In light of this outreach, the FASB requested the staff to explore the possibility of adding a de minimis or similar threshold to the definition of a business (in a manner consistent with Issue 98-3) as well as the factors an entity would consider in making its assessment.

The ASC Master Glossary defines a business as follows:

An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants.

The FASB staff’s outreach revealed that:

  • Some stakeholders broadly interpret the phrase “capable of being conducted and managed for the purposes of providing a return.”
  • Stakeholders “generally interpret outputs to be goods or services provided to customers. However, the current guidance only appears to require the ability to provide a return, which could not only be related to nonrevenue generating activities, but also could be associated with lowering costs or other economic benefits.”

In light of this outreach and the Board’s desire for start-up entities to continue to qualify as a business under ASC 805, the Board tentatively decided to retain the notion of “capable” in the definition of a business and instructed the staff to explore revising the definition of “outputs.”

The staff also noted that the guidance in ASC 805 does not require acquired inputs and processes to be self-sustaining (i.e., an acquirer can apply a market participant’s viewpoint in determining whether the acquired set of activities meets the definition of a business). However, ASC 805 does not provide additional guidance on how to apply a market participant’s viewpoint. As a result, the Board tentatively decided to retain the market-participant concept in the definition of a business but to ask the staff to provide clarifying guidance on how to analyze an acquisition from a market-participant perspective.

Lastly, the Board considered whether to provide illustrative guidance on how to apply the definition of a business and decided to defer action on this matter to a later date.

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1 For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s "Titles of Topics and Subtopics in the FASB Accounting Standards Codification."

2 EITF Issue No. 98-3, “Determining Whether a Nonmonetary Transaction Involves Receipt of Productive Assets or of a Business” (nullified).

FASB makes tentative decisions related to clarifying the definition of a business Image

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