FASB Clarifies What Exactly a Business Is

Chris Gaetano
Published Date:
Jan 6, 2017

The Financial Accounting Standards Board (FASB) released a new update that provides a clarified definition for what exactly counts as a business in order to address what the board said was confusion expressed by stakeholders over the matter. 

Previously, a business was defined as "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." In order to meet this definition, the entity in question needed to have three elements: inputs, processes and outputs, referred to in the literature as "a set." 

The literature, however, did allow for certain aspects of a set to be missing and still be defined as a business. For instance, while many businesses had outputs, these were not strictly necessary. Meanwhile, a seller need not have inputs and processes in the set if market participants are capable of acquiring it and using it to continue producing outputs, like by integrating it with the buyer's own inputs and processes. The FASB also noted that the standards did not specify the minimum inputs and processes required for a set to be defined as a business. These all combined to sometimes lead to overly broad interpretations of the standard, according to the FASB. Some stakeholders, for example, said that the presence of any process, whether or not it actually had anything to do with the ability to create outputs, could give rise to a business. The confusion has also led to people classifying things that are closer to asset acquisitions as business acquisitions instead. 

To address this, the new standard says that when substantially all of the fair value of the group of assets acquired or disposed of is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not a business. Further, for a set to be considered a business, it must include, at minimum, an input and a substantive process that, together, significantly contribute to the ability to create output—this change also removes the part where an input and process is not required if a market participant can replace those missing elements. 

To meet this minimum definition, the organized workforce must have the necessary skills, knowledge or experience to perform an acquired process or group of processes that, when applied to another acquired input or inputs, is critical to the ability to develop or convert those inputs into outputs. If the process is considered ancillary or minor in the context of all the processes required to create putouts, then it is not considered critical. Inputs, meanwhile, include intellectual property that could be used to develop a good or service, resources that could be developed to create outputs, or access to necessary materials or rights enabling the creation of future outputs. So for example, according to the FASB, things like technology, mineral interests, real estate and in-process research and development. 

Under this definition, an output is still not strictly required under the definition. If a set does include an output, inputs and substantive processes can also include an acquired contract that provides access to an organized workforce, an acquired process or processes when applied to an acquired input contributes to the ability to continue producing outputs and either cannot be replaced without significant cost, effort or delay or significantly contributes to the ability to continue producing outputs and is considered unique or scarce. 

The new standard also clarifies that even if a set has outputs, continuation of revenues does not, in its self, indicate that both an input and a substantive process have been acquired, and so contractual arrangements that provide for the continuation of revenues should be excluded from the analysis as to whether a process has been acquired. 

“Stakeholders expressed concerns that the definition of a business is applied too broadly and that many transactions recorded as business acquisitions are, in fact, more akin to asset acquisitions,” stated FASB Chairman Russell G. Golden. “The new standard addresses this by clarifying the definition of a business while reducing the cost and complexity of analyzing these transactions.”

For public companies, the ASU is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. For all other companies and organizations, the ASU is effective for annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019.

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