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Project to Define a Business Moves Forward

The FASB wants to amend its guidance to help accountants distinguish between a business and a group of assets. The accounting board is beginning its work on the definition of a business by clarifying the application of the asset- or entity-based guidance for the nonfinancial assets in an entity.

The FASB on May 21, 2015, continued refining the definition of a business in an effort the standard-setter hopes will help accountants distinguish between transactions that should be treated as acquisitions or disposals of assets and acquisitions or disposals of businesses.

The distinction is important because if a business buys or acquires another business, it must follow FASB ASC 805, Business Combinations . The distinction is often clear, but questions arise in some real estate deals or in cases such as the purchase of the rights to new drug patents that involve hiring the scientists who developed them.

The discussion was a follow-up to the FASB’s December 2014 decision that a set of activities and assets must include inputs and one or more “substantive processes” that contribute to the ability to create outputs to be considered a business.

Outputs typically are considered goods or services for customers. Inputs can include people, money, raw materials, finished goods, and other economic resources that create, or have the ability to create, the goods or services.

The December vote was a move toward a significant change from current guidance, which doesn’t require a business to include the production of goods or services, just that there be inputs and processes in place. FASB ASC 805 explains what it takes to for a group of assets to be considered a business, but the standard does not specify what types of inputs or processes are required.

The FASB on May 21 agreed that to simplify accounting further, it will set an initial test to help entities determine whether they pass or fail the definition of a business. The test, or threshold, will state that in order for a set of activities to be considered an asset as opposed to a business, “substantially all” of the activities’ fair value has to be represented by a single tangible or identifiable, intangible asset.

“This is intended to provide sort of a practical way for people to evaluate whether a transferred set is an asset or a business,” FASB practice fellow Jennifer Hillenmeyer told the board.

FASB members debated the idea of this threshold at length, and Chairman Russell Golden said the board needed to make a decision and move on.

“I suspect we can’t make this perfect, no matter what we do; ultimately, this is just a scope-out of the rest of the model,” Golden said. “If we’re going to err, we might want to err on the side of being conservative.”

FASB members also had trouble deciding whether to add indicators to help determine when “substantive processes” that define a business are in place.

Vice Chairman James Kroeker cautioned against adding too much guidance that would accomplish little more than making accountants do more much analysis.

“This whole area is challenging to me as to whether we’re going to actually improve accounting practice by putting a bunch of additional words behind a general concept or not,” Kroeker said. “This is one small aspect of accounting… I’m a little concerned people are going to spend painstaking time interpreting new sets of words — massive energy behind this.”

Hillenmeyer told the board that businesses exert a lot of effort to make the determination, and the businesses polled by FASB staffers agreed with the staffers’ recommendations to add more guidance and attempt to simplify the decision.

“The feedback has been that this is more operational than what it has been,” Hillenmeyer said.

The board also agreed to develop a framework for when inputs and processes together “substantively” contribute to the ability to create outputs. The framework would include several factors to help make the distinction between a business and a non-business.

The accounting board plans to develop examples that will help in making the distinction for a possible proposed amendment to U.S. GAAP.

The FASB’s project to define a business started as a way to clarify the application of the asset- or entity-based guidance for the nonfinancial assets in an entity. After adding the broader project to its agenda in May 2013 and then setting it aside, the board in October 2014 realized it had to first clarify the definition of a business.

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