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Convergence Gains May Be Undone by Plan to Define a Business

The FASB is to trying redefine the word business as it’s applied in U.S. GAAP. The board’s interest in the effort has been driven by questions that have been raised about the recently published revenue standard and the 2007 guidance on business combinations. The definition in the business combinations standard is considered too broad and is often applied to acquisitions that should have been recognized as assets.

The FASB is moving forward with a project to redefine the word business as it’s applied in U.S. GAAP.

At its October 8, 2014, meeting, the accounting board decided to begin the effort by revising the definition, while trying to ensure that the changes don’t create differences between U.S. GAAP’s definition and the one in IFRS. As the project proceeds, board members will also look at how the definitions for business and asset have evolved.

In addition, the FASB’s parent organization, the Financial Accounting Foundation (FAF), is reviewing SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, and the FASB plans to look at how the review’s findings should factor into the project as it proceeds. The review may affect amendments to the guidance for recording sales or spin-offs of assets, subsidiaries, or interests in joint ventures.

The definition of a business has been revised before, most recently in 2007 with the publication of SFAS No. 141(R), Business Combinations, (FASB ASC 805). At the same time as the FASB published SFAS No. 141(R), the IASB released IFRS 3, Business Combinations, and the standards were seen as the first major milestone in converging all of U.S. GAAP and IFRS.

More recently, the convergence effort has lost momentum, although the May 2014 publication of the revenue recognition standards is generally regarded as both the most significant accomplishment from the convergence effort and, apart from the continuing project on lease accounting, one of the last significant decisions the boards are expected to collaborate on.

Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, included sales of nonfinancial assets sales in its scope. But since the revenue standard’s publication, questions have been raised about how to record partial sales or sales of minority interests in the assets.

The FASB has been considering a revision to the definition of a business since May 2013 when the FAF completed its review of SFAS No. 141(R). The review found that the standard’s definition was too broad and included some acquisitions that were accounted for as businesses when they probably should have been recognized as assets.

“We have created complexity because we have different accounting if it’s an asset acquisition or a business acquisition. We have different accounting if it’s selling assets versus selling businesses,” said FASB Chairman Russell Golden. The problem is that in many cases the economics of the sale of an asset or a business are the same, but the standards call for different accounting treatment.

“That’s what puts pressure on the definition of a business,” Golden said. “We have incentivized people to push the envelope to determine if it’s a business or an asset.”

Board members are also concerned that any work they do may create an inconsistency between the FASB’s revenue standard and IFRS 15, Revenue from Contracts with Customers. They’re also concerned about the risk of creating inconsistencies between SFAS No. 141(R) and IFRS 3.

One of the key issues that may affect the revenue standard is the use of the term in-substance real estate, which, while not defined, requires some judgment upon the part of a company and its auditor to determine whether the new revenue standard should apply to a sale of individual assets.

“There are knock-on effects that are going to be there in terms of revenue recognition if we eliminate the need for the term because there’s a reference to the term in the new literature,” said FASB member Thomas Linsmeier.

But FASB Vice Chairman James Kroeker said there’s little common ground in terms of everyday application for the definition of a business shared by SFAS No. 141(R) and IFRS 3. The standards use the same words in their definition, but they’re interpreted differently by the companies that have to follow them.

“If people define businesses differently under IFRS than they do under U.S. GAAP, the thing that matters is reporting, and reporting isn’t converged. But people might have the illusion that we are,” Kroeker said.

Despite board members’ concerns about the problems they might cause, particularly in terms of convergence, by revising the definition, they’re almost resigned to the need to make a change.

“In every project we deal with this, and we come up with a different answer,” said FASB member Marc Siegel.

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