The Business combinations and noncontrolling interests guide has been updated through October This guide discusses the definition of a business and transactions in the scope of accounting for business combinations under ASC We provide guidance on identifying the acquirer, determining the acquisition date, and recognizing and measuring the net assets acquired. In addition, we discuss the subsequent accounting for goodwill and indefinite-lived intangible assets.
Other topics covered include common control transactions and pushdown accounting. The accounting for business combinations ASCdiscontinued operations, divestitures, intangible assets, impairments and segment reporting continue to pose Beth Paul.
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A guide to accounting for business combinations (third edition)
Download the PDF version. In addition, stakeholders said that analyzing transactions under the current definition is difficult and costly. Another difference is that in a business combination, the assets acquired are recognized at fair value and goodwill is recognized; in an asset acquisition, however, the cost of the acquisition is allocated to the assets acquired on a relative fair value basis and no goodwill is recognized.
The scope of ASC raised questions about the interaction between the definition of a business and the guidance on in-substance nonfinancial assets. The FASB intends to address the accounting for partial sales of real estate and clarify that a business is outside the scope of ASC in the second phase of its project on the definition of a business.
The screen requires a determination that when substantially all of the fair value of the gross assets acquired or disposed of is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not a business. The screen will reduce the number of transactions that an entity must further evaluate to determine whether they are business combinations or asset acquisitions.
The ASU provides a framework to assist entities in the evaluation of whether both an input and a substantive process are present, and it removes the evaluation of whether a market participant could replace the missing elements. The standard also provides examples that illustrate how an entity should apply the amendments in determining whether a set is a business. As noted above, the ASU provides a screen for determining when a set is not a business. The ASU requires an entity to compare the fair value of a single identifiable asset or group of similar identifiable assets with the gross assets acquired, as opposed to the total consideration paid or net assets, to ensure that debt or other liabilities do not affect the analysis.
The gross assets acquired exclude cash and cash equivalents, deferred tax assets, and goodwill resulting from the effects of deferred tax liabilities. However, they include the consideration transferred in excess of the fair value of the net assets acquired.
However, in some cases, an entity would need to perform a quantitative assessment.
In-place lease intangibles, including favorable and unfavorable intangible assets or liabilities, and the related leased assets. Different major classes of tangible assets for example, inventory, manufacturing equipment, and automobiles.
The example below, which is reproduced from the ASU, illustrates the application of the screen. Case A: Acquisition of Real Estate. Scenario 1. ABC acquires a portfolio of 10 single-family homes that each have in-place leases. The only elements included in the acquired set are the 10 single-family homes and the 10 in-place leases.
Each single-family home includes the land, building, and property improvements. Each home has a different floor plan, square footage, lot, and interior design. No employees or other assets are acquired.
ABC concludes that the land, building, property improvements, and in-place leases at each property can be considered a single asset in accordance with paragraph B. Additionally, the in-place lease is an intangible asset that should be combined with the related real estate and considered a single asset.
Each home has a different floor plan; however, the nature of the assets all single-family homes are similar. In addition, the ASU clarifies that a substantive process is capable of being applied to inputs to create outputs and is therefore distinguishable from 1 processes that do not typically create outputs, such as accounting, billing, or payroll, or 2 processes that are considered ancillary or minor in the context of all of the processes required to create outputs.
The standard includes different criteria for entities to evaluate depending on whether a set has outputs. When a set does not have outputs e. The ASU notes that in the evaluation of whether an acquired workforce is performing a substantive process, the following factors should be considered: A process or group of processes is not critical if, for example, it is considered ancillary or minor in the context of all the processes required to create outputs.
Intellectual property that could be used to develop a good or service. Resources that could be developed to create outputs. Access to necessary materials or rights that enable the creation of future outputs. Examples of inputs that could be developed include technology, mineral interests, real estate, and in-process research and development.This update was issued in response to feedback from stakeholders that the definition of a business was applied too broadly, causing many transactions to be recorded as business combinations that may have been more appropriately classified as asset acquisitions.
By clarifying the definition of a business, FASB intended to add guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses.
ASC previously defined these as follows:. Under the old definition, a set could be classified as a business without all inputs or processes that a seller used to operate the business if market participants could acquire the business and continue to produce outputs e. Prior guidance further complicated the definition of a business by indicating that outputs are not always required to qualify as a business.
However, it removes considerations that complicated the prior definition and identifies new considerations that have less ambiguity. First, the market participant exception was removed. In addition, new guidance indicates that while not all inputs or processes that a seller uses to operate the business are necessary, the set must minimally include an input and a substantive process that together significantly contribute to the ability to create output in order to be classified as a business.
Second, the FASB changed the definition of output to be the result of inputs and processes to those inputs that provide goods or services to customers, investment income such as dividends or interestor other revenues.
Importantly, the new guidance outlines a framework in ASC A through 5E to determine when a set is or is not a business Figure 1. When applying the framework outlined in Figure 1, ASU clarifies that the following should both be considered single assets in accordance with ASC B:.
When assessing a group of similar assets, the following items do not meet the stipulated criteria:. Furthermore, the new guidance stipulates that a continuation of revenues does not, on its own, indicate that both an input and a substantive process have been acquired.
Thus, contractual arrangements, such as customer contracts, customer lists, and leases when the set is a lessorshould be excluded from the analysis outlined in ASC E. The new definition of a business does not change the acquisition method of accounting for business combinations or the accounting for asset acquisitions outlined in ASC However, given the narrower definition of a business outlined in ASUasset acquisitions have become more frequent, particularly in the life science, real estate, and asset management industries.
Therefore, we highlight some key differences between the accounting treatment for business combinations and asset acquisitions under U.
For business combinations, ASC states that an intangible asset shall be recognized as an asset apart from goodwill if it falls under the following conditions:. To the extent that the purchase price plus the fair value of any noncontrolling interest in the acquiree exceeds the net of the fair values of the tangible and intangible assets acquired and liabilities assumed, the excess value shall be recognized as goodwill ASC Because an assembled workforce is not an identifiable asset in business combinations, it is subsumed into goodwill ASC Conversely, there is a much lower threshold for recognizing intangible assets in asset acquisitions.
Given the less stringent recognition criteria, an assembled workforce may be recognized as an intangible asset in asset acquisitions. Goodwill, however, is not recognized.
Instead, the cost of the group of assets i. Otherwise, they are expensed. Transaction cost recognition differs between asset acquisitions and business combinations. Per ASCtransaction costs should generally be capitalized as a component of the purchase price for asset acquisitions. The costs should then be recognized as they become payable. For business combinations, ASC indicates that transaction costs should not be recorded as a component of the purchase price and should instead be expensed as incurred.
Because transaction costs are capitalized in asset acquisitions rather than expensednear-term net income will be higher but long-term net income will be lower as depreciation and amortization are higher due to a higher asset base. There are also notable differences regarding contingent consideration measurement. In asset acquisitions, contingent consideration is recognized when probable and reasonably estimable, as discussed in ASC When resolved, the amount by which the fair value of the contingent consideration issued or issuable is in excess or shortfall of the amount that was recognized as a liability shall increase or decrease the cost of the investment, as discussed in ASC A.
In business combinations, ASC indicates that acquirers shall recognize the fair value as of the acquisition date as part of the consideration transferred. Changes in the fair value for contingent liabilities will be recognized in earnings until the contingency is settled. In the event that the fair values of the tangible and intangible assets acquired and liabilities assumed exceed the total purchase price of the transaction in a business combination, the resulting gain shall be recognized in earnings on the acquisition date, as discussed in ASC For asset acquisitions where this situation holds true, the purchase price should be allocated to the individual assets acquired or liabilities assumed based on relative fair value.
One final area of note relates to the measurement period for business combinations and asset acquisitions. In a business combination, the acquirer has up to one year to make provisional adjustments to the amounts recognized at the acquisition date to reflect new information obtained about material facts and circumstances that existed as of the acquisition date.
However, guidance for asset acquisitions does not recognize the concept of a measurement period.The IC received a request to clarify how an entity accounts for the acquisition of a group of assets that does not constitute a business.
FASB Clarifies the Definition of a Business (January 13, 2017)
Specifically, the submitter asked for clarity on how to allocate the transaction price to the identifiable assets acquired and liabilities assumed when a the sum of the individual fair values of the identifiable assets and liabilities in the group differs from the transaction price, and b the group includes identifiable assets and liabilities initially measured both at cost and at an amount other than cost.
The submitter believed that the above requirement is tantamount to establishing initial measurement requirements for a group of assets acquired that is not a business. However, other Standards also specify the initial measurement requirements for particular assets and liabilities. Accordingly, the submitter believed that there is a conflict between the initial measurement requirements of IFRS 3.
The Staff believe that if a material difference exists between the transaction price of the group and the sum of the individual fair values of the identifiable assets and liabilities, the entity should reassess 1 whether it has correctly identified all of the assets acquired and all of the liabilities assumed, and 2 the determination of the individual fair values, to reconfirm whether, and why, such a difference exists.
Under this view, IFRS 3. Instead, it sets out how to determine the transaction price of the individual assets acquired and liabilities assumed. Once the transaction price of each identifiable asset and liability has been determined, each of the assets and liabilities will then be measured initially by applying the relevant Standards.
The steps to be applied under this view are as follows:. This is because various Standards e. This view interprets IFRS 3. To the extent that the IFRS 3. Accordingly, the steps to be applied under this view are as follows:.
A roadmap to accounting for business combinations
The Staff recommend that the IC not add this issue to its agenda on grounds that there is not sufficient evidence that the two views set out above would lead to materially different outcomes. Instead, the Staff recommend that the IC issue a tentative agenda decision containing the two views set out above, and indicate that they are the only reasonable ways in which to interpret the requirements of IFRS 3. Most IC members were in favour of view 1 but acknowledged that view 2 cannot be precluded.
They noted that view 2 is mostly applied in practice when level 1 financial instruments are included in the group of assets acquired. Allocating to level 1 financial instruments a transaction price that equals their fair value would likely reflect the economics of how the transaction price for the group of assets was negotiated in the first place.
The IC also debated at length whether: 1 further research on the topic is needed to ascertain whether the two views would lead to materially different outcomes, 2 any standard-setting activities should be undertaken to narrow the existing practice to any particular view, and 3 the tentative agenda decision should allow a choice of two views as that might inadvertently lead to more diversity in practice especially for entities that thought view 1 was the only possible interpretation.
Throughout the discussion, most IC members repeatedly observed that even though the two views may be conceptually different, in practice they do not lead to materially different outcomes. Further research would unlikely shed any light on the differences between these two views because entities simply do not provide such comparative information in their financial statements.
Business combination accounting
However, the stakeholders can comment on the tentative agenda decision if they think that the different views would indeed lead to materially different outcomes, especially in light of the proposed revised definition of a business, which is expected to result in more acquisitions being accounted for as asset deals, as opposed to business combinations.
However, the IC members suggested that the tentative agenda decision:.December 14, What's inside. Why does it matter? What is a business? Disposal transactions. Public company reporting. Did I buy a group of assets or a business? Why should I care? For many transactions, the determination will be straightforward. However, the current guidance will cause many transactions that are "on the edge," and previously would have been accounted for as asset acquisitions, to be accounted for as business combinations.
Why is this determination important? While the measurement of assets and liabilities in both types of transactions will yield similar results, several differences can arise that can have a significant impact on a company's earnings, financial ratios, and business metrics. Determining whether a business has been acquired has far reaching business and accounting implications. To illustrate, the table below outlines some of the key areas where the accounting treatment can differ.
Asset acquisition. Measurement of assets and liabilities. Fair value. Allocate purchase consideration based on relative fair values. Transaction costs. Generally record when probable and reasonably estimable. Capitalize as an indefinite lived asset until project completed or abandoned. Expense assuming no alternative future use. Recognize as.
Cannot be recognized. Recognize at fair value if determinable; otherwise, when probable and reasonably estimable. Assembled workforce. Subsumed within. A business is an integrated set of assets and activities capable of being managed to provide a return to its owners.
In many transactions, the asset or business determination will be straightforward. For example, the acquisition of an operating company active in the marketplace will qualify as a business, whereas the purchase of a single machine will be accounted for as an asset acquisition. However, in other instances, this assessment can become more complex and judgmental. In making this determination, it is important to: 1 identify the elements in the acquired group i.
The table below outlines some factors that may distinguish business combinations from asset acquisitions.IAS 36 Impairment of Assets
Business combination. Key business processes acquired. No processes acquired or only administrative processes acquired. A market participant could manage the assets to provide a return to its owners.
A market participant could not manage the assets to provide a return to its owners without combining them with other assets.The definition of a business may affect many areas of accounting, including acquisitions, disposals, goodwill impairment, and consolidation.
According to feedback received by the FASB, the previous guidance was thought to be applied too broadly, which resulted in too many transactions qualifying as business combinations. Using the new definition, more acquisitions in certain industries, such as real estate and pharmaceuticals, will be asset acquisitions. As a result, acquisition costs will be capitalized as part of the assets acquired, rather than being expensed as is the case with business combinations. For acquisitive companies that are suddenly buying assets instead of businesses, this could mean a substantial benefit to net income in the short term.
However, over the long term, depreciation and amortization expense would increase as a result of the higher asset base. Regardless, net income will be less volatile going forward, which should allow for better trend analysis and less reliance on non-GAAP measures. For business combinations, GAAP allows for a measurement period of up to a year to make adjustments to the initial acquisition accounting for information that was unknown at the time of acquisition.
The cumulative impact of the adjustment is recognized in the reporting period in which the adjustment is identified within the respective line items affected. No such measurement period guidance exists for asset acquisitions, as the accounting for these acquisitions is thought to be inherently less complex. Despite the perceived lack of complexity, it can often be challenging to complete the accounting for certain asset acquisitions, especially if a deal closes near a period end.
Any subsequent adjustments to the accounting for asset acquisitions will be considered errors. To minimize the occurrence of errors, we recommend that companies involve consultants to the extent they are needed earlier in the deal process to ensure quick completion of the accounting after close.
If substantially all of the acquisition is made up of one asset or several similar assets, then the acquisition is an asset acquisition. Three types of scenarios that are more likely to result in asset acquisitions under the new guidance are:. The definition of a business can also impact disposition accounting. When a business is disposed of, any related goodwill is derecognized. However, as more disposal transactions are expected to be of assets after adoption of the new definition, goodwill that arose upon the acquisition of a business would remain.
This may have the immediate impact of increasing the gain on sale, as the carrying value of the asset being derecognized would be less than it would have been as a business with goodwill. However, this may also increase the likelihood of goodwill impairment in the future. When the assets are derecognized, headroom related to the goodwill impairment test will likely decrease.
The revised definition of a business is new, and there is no certainty as to how the marketplace will react to it. The discussion above is not a comprehensive list of the implications of the revised definition, but rather four that users may find impactful. In addition, the FASB has an ongoing project related to addressing certain differences in the accounting between asset and business acquisitions that may ultimately eliminate some of the differences between the two frameworks.
Heather Horn. David Schmid. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network.The question is important and there are significant consequences to getting the answer wrong or not considering the question at all!
An entity first needs to determine whether the assets acquired and liabilities assumed constitute a business IFRS 3. If they do not meet the definition of a business, then the default is to account for the transaction an asset purchase. Therefore, outputs themselves are not required. Input: are economic resources, such as intellectual property, access to necessary materials, employees and non-current assets such as intangible assets or the rights to use non-current assets.
Process: is any system, standard, protocol, convention or rule, such as strategic management processes, operational or resource management processes. Administrative processes are specifically excluded. Output: is a return in the form of dividends, lower costs or other economic benefits. The determination of whether a transaction is a business acquisition or an asset purchase is a judgement call that must be disclosed.
The definition of a business includes inputs and processes and may also result in outputs, although outputs are not necessary for a business to exist. B7 that when applied to inputs creates, or has the ability to create, outputs.
Examples of processes include strategic management, operational and resource management. Inputs are economic resources that create, or have the ability to create, outputs when one or more processes are applied, and include intangible assets or the rights to use non-current assets.
Therefore both assets and processes must be included in the acquisition, even though all necessary processes need not be acquired some processes may be contributed by the acquirer IFRS 3.
If no processes are included, then the transaction is an asset purchase; if this was not the case, then any asset purchased for use in an existing business would meet the definition of a business, which would be non-sense. There are no activities inherent in a rent-roll, instead leasing and other management processes are applied to it. Where the acquisition includes both inputs and some level of process over and above administrative functions, which are specifically excluded by the definition the determination can involve significant judgement.
The IFRS Interpretations Committee White Paper of May addressed the application of this principle in practice by different sectors, including the real estate sector, and in different jurisdictions. One view in practice is that the processes acquired must have a level of sophistication that involves a degree of knowledge unique to the assets being acquired for a business to exist.
Common themes in the responses received include:. Note that these necessary processes meet both the definition in IFRS 3 and the English language definition, while in-place leases acquired do not. The view that a level of sophistication is required is predominant in Europe and Australia and is consistent with the requirement that processes be at a more supervisory or management level as per the definition: strategic management, operational and resource management.
This is logical given the fact that and IFRS 3 are identical. The review found that stakeholders find it difficult to apply the definition of a business in practice.