Was a Business Acquired? Updates to the Definition of a Business

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A publication of the Professional Standards Group
January 2017
Was a Business Acquired? Updates to the Definition of a Business
In its first accounting update of the new year, the
Financial Accounting Standards Board (FASB)
released guidance clarifying the definition of a
business. Accounting standards update (ASU) 2017-
01, Business Combinations (Topic 805) Clarifying
the Definition (ASU 2017-01) seeks to narrow the
circumstances where a set of assets and activities
qualifies as a business. The changes are anticipated
to result in more transactions being accounted for as
asset acquisitions instead of business combinations.
Changes in ASU 2017-01 reflect the first phase of
the business definition project. Phase two, which
is expected to be issued soon, provides guidance
related to partial sales or transfers of assets within
ASC Subtopic 610-20. A third phase will delve into
whether there are differences in the acquisition
accounting and derecognition guidance for assets
and businesses and whether those differences should
be aligned.
Background
Under current U.S. GAAP, a set of assets and activities
that is a business contains up to three elements:
inputs, processes and, usually, outputs. To be a
business all of the inputs and processes necessary to
operate the set of assets and activities are not required
if the inputs and process used to produce outputs can
be acquired, such as by integration into the buyer’s
existing inputs and processes. An “output” refers to
the ability to provide a return in the form of dividends,
lower costs or other economic benefits to investors
or other owners. As a result of these provisions, the
definition of a business has encompassed many
transactions that many have argued would be more
appropriately accounted for as asset acquisitions.
Under the current definition of a business, the
purchase of rental real estate, ships or equipment
may often be identified as acquisitions of a business.
For example, the acquisition of a building that is under
lease to a restaurant at the time of acquisition may be
determined to be a business even if no employees,
marketing, maintenance or other processes are
obtained. In such a situation, inputs (land, building and
lease) and outputs (lease revenue) are acquired. The
lack of the acquisition of processes may not impact
the analysis of whether a business was acquired
because those processes may readily be replaced by
a market participant.
Changes to the Existing Guidance
The revised guidance retains the concept that a
business has inputs, processes applied to those
inputs and, usually, outputs. ASU 2017-01 modifies the
application guidance to further clarify the requirements
that a set of assets and activities must meet to be a
business. Changes to these requirements include:
• Introduction of a “screen” that is applied prior
to evaluating other aspects of the definition of a
business;
• Narrowing the definition of an output; and
• Introducing new requirements related to inputs
and processes.

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Screen: When an entity enters into a transaction
where it acquires a set of assets and activities prior
to evaluating the definition of a business, it will apply
a “screen”. The screen acts as a filter to prevent
certain types of assets and activities from meeting the
definition of a business. It applies to a set of assets
and activities when substantially all of the fair value
of the gross assets acquired is concentrated in a
single identifiable asset or a group of similar assets.
The guidance further specifies that assets should be
grouped based on their similarity in the nature of the
assets and risks associated with managing the assets.
Specifically targeting real estate entities, the revised
definition states that tangible property that cannot be
physically removed, such as land and building and
the related in-place leases should be grouped for
purposes of applying the screen.
In the example discussed above about the acquisition
of a building that is leased to a restaurant, the screen
would apply because the fair value of the land and
building, combined with the in-place lease, represents
substantially all of the fair value of the gross assets
acquired.
Definition of an Output: The definition of an output
was also modified to reduce the instances where a
set of assets and activities will meet the definition of
a business. Previously, outputs included economic
benefits, such as the lowering of costs consistent with
the purpose of a business. Under the revision, an
output is defined as results that generate revenues or
investment income.
Inputs and processes: Under the revision, an acquired
set of assets and activities must include at least one
inputandasubstantiveprocessthattogethercontribute
to the ability to create an output in order to qualify as
a business. In scenarios where outputs are included
in the set of assets and activities, the mere existence
of outputs prior to and subsequent to a transaction
does not automatically result in a determination that
a substantive process exists. Rather, an evaluation
is performed to consider whether the processes
acquired contribute significantly to the creation of the
outputs.
As with the prior guidance, a set of assets and
activities may be a business even when the set does
not include outputs. ASU 2017-01 creates a framework
for evaluating a set of assets and activities which
have no outputs that is narrower than the existing
requirements. A substantive process may only exist
(i.e. a business may exist) in a transaction that does not
include outputs if an organized workforce is acquired
and that organized workforce engages in processes
that are not ancillary or minor (ex. bookkeeping) that
are applied to inputs that are being developed into
outputs.
Expected Impact
The changes to the definition of a business are
expected to reduce the number of transactions that
must be accounted for as a business combination
under ASC Topic 805 Business Combinations (ASC
Topic 805). Transactions that are no longer in the
scope of ASC Topic 805 will not be accounted for
under the acquisition method; instead, they will be
accounted for as asset acquisitions.
Asset acquisitions are accounted for at historical cost
instead of fair value. However, the revision to the
definition will not eliminate the need to determine the
fair value of assets acquired when these transactions
cease to meet the definition of a business. In an asset
acquisition, an entity is required to allocate the cost
to the assets acquired based on those assets fair
value. Therefore, in the example discussed above for
the acquisition of a leased building, a reporting entity
would determine the fair value of the building, land
and in-place lease, and proportionately allocate the
cost between those three assets based on the relative
amounts of each asset’s fair value.
Although fair value of the individual assets is

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The information in this MHM Messenger is a brief summary and may not include all the details relevant to your situation. Please
contact your MHM auditor to further discuss the impact on your audit or audit report.
determined for transactions under both models of
accounting, differences in the accounting for asset
acquisitions and business combination do exist. For
instance, in the example involving the acquisition
of a leased building, the nature of the lease as a
direct-financing, sales-type, or operating lease is re-
evaluated as of the date of acquisition, whereas in a
business combination the lease type is retained from
the date of the leases inception. Three of the most
significant differences between an assets acquisition
and a business combination are:
1. In an asset acquisition goodwill or gain is not
recognized;
2. In an asset acquisition transaction costs are
capitalized instead of expensed; and
3. If an asset acquisition includes a workforce, the
intangible asset of the workforce is allocated
a portion of the cost, whereas in a business
combination the workforce is subsumed into
goodwill.
Lastly, the adoption of the new definition may
impact other areas of U.S. GAAP that use the term
“business.” Perhaps most significantly, ASC Topic
810 Consolidations uses the definition of a business
when determining whether relationships with a legal
entity are in scope of the variable interest entity (VIE)
model. Entities adopting the new guidance may need
to re-evaluate their conclusions when the business
scope exception was applied.
Effective Date and Transition
The guidance will be applied prospectively as of
the adoption date. No additional disclosures will be
required at adoption. Public business entities will
apply ASU 2017-01 to annual and interim periods
beginning after Dec. 15, 2017. Nonpublic business
entities will apply the guidance for annual periods
beginning after Dec. 15, 2018 and interim periods
within annual periods beginning after Dec. 15, 2019.
Entities will have the option to early adopt the changes.
Entities may apply the new definition to transactions
that take place before the effective date (including
prior to the issuance of ASU 2017-01), so long as the
transaction has not already been recorded in financial
statements that are issued or available for issuance.
For comments, questions or concerns about how the
standard will affect your reporting, please contact
Mark Winiarski of MHM’s Professional Standards
Group. Mark can be reached at mwiniarski@cbiz.com
or 816.945.5614.

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