Definition of a business – Update on IASB’s proposals
At its October 2015 meeting, the IASB tentatively decided to propose amendments to IFRS 3 Business Combinations related to the definition of a business. IFRS 3 and the equivalent FASB requirements are aligned; the two boards having developed the requirements in a joint project. The amendments being proposed will be the same as those being proposed by the FASB.
It was observed in that meeting that the IFRS Interpretations Committee had also discussed some issues relating to the definition of a business. The IASB asked that the proposed amendments to IFRS 3 be shared with the Interpretations Committee.
The paper for this session set out the proposed amendments to IFRS 3, along with the staff’s analysis of how the amendments would address the issues that had been raised to the Interpretations Committee about the definition of a business.
The staff concluded that the proposed amendments would help solve the issues that had been raised to the Interpretations Committee. The Interpretations Committee were asked whether they agreed with this conclusion and whether they had any comments on the proposed amendments to IFRS 3.
Interpretations Committee discussion
The general consensus of the Committee members was that overall; the proposals would be useful improvements to IFRS 3 and would address the issues that had arisen in practice. It was acknowledged that this would always be an area of judgement, but that the proposals provided a helpful framework for applying that judgement.
The Committee members made suggestions for improvements to some of the proposals, with Proposal 3 “to not consider a set a business if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets” attracting the greatest discussion.
With respect to Proposal 3, there were concerns expressed that this could be tricky to apply in practice. One Committee member highlighted the fact that situations might arise where the bulk of the fair value was concentrated in assets that were not part of the primary focus of the business, for example, in a start-up biotech company that happened to own a building and had in-process R&D (“IPR&D”), the bulk of the fair value could be in the building rather than in the IPR&D, in which case, an entity might come to a different conclusion under this test. Another Committee member observed that it appeared that if an entity was going to determine whether the fair value of the assets acquired was concentrated in a single asset by comparing it to the fair value of the gross assets, the entity would be required to do a whole purchase price allocation to get there, which seemed to defeat the purpose of then saying it was an asset acquisition. The Committee member added that if the other proposals were followed, this step would not be necessary as an entity would get to the answer anyway. Several Committee members highlighted unit of account issues that could arise under this proposal. It was specifically noted that under IFRS today, investment property was considered to be a single unit of account (including all in-place leases), and questioned whether under this proposal entities would be required to separate out the value of property and the value of the leases.
With respect to Proposal 1, it was observed that what was considered a substantive process would create some judgement issues, and a Committee member suggested that in addition to the proposed examples, some further guidance on this could be helpful. Another Committee member noted that it was not clear whether, if an entity (i.e. an exploration entity) acquired inputs (i.e. tenements) and a workforce (undertaking drilling and exploration activities) that were capable of producing something on the path to the ultimate output, but not the ultimate output; that would be a business or not.
With respect to Proposal 4 “revising the definition of outputs to focus on goods and services provided to customers”; a Committee member questioned whether a customer could be internal. It was noted that this question had arisen in the joint IASB FASB meeting, and confirmed that a customer could be internal.
In general, it was observed that one of the consequences of the amendments was that there would likely be more transactions accounted for as asset acquisitions, and one Committee member noted that the tension between what securities commissions regarded as business acquisitions versus the answer one would arrive at under IFRS, would be exacerbated.
With respect to the examples, one Committee member noted that it was helpful to have examples that fell on both sides of the line, and while this was an area where judgement was needed, the answers in the examples would be where most entities should get to, which should result in more harmonised application of the guidance by both US and IFRS preparers. Another Committee member suggested that it would be helpful to include examples from the upstream extractive and financial services industries because there were a number of issues in practice in this area coming from these industries.
No decisions were made at this meeting. The Interpretations Committee’s comments will be reported back to the IASB at its December 2015 meeting.