As elementary as it may sound, it’s not always clear under accounting rules whether a particular transaction constitutes the purchase or sale of a business. The Financial Accounting Standards Board has finalized new guidance meant to make it more clear.
FASB finalized Accounting Standards Update No. 2017-01 to clarify the definition of a business in Topic 805 of the Accounting Standards Codification, which provides guidance on how to account for various types of business combinations. The new definition is meant to help companies better distinguish when a particular transaction should be accounted for as a business combination compared with when it’s simply the sale or purchase of an asset or a group of assets. Beyond business combination accounting, the determination also is important in accounting for goodwill and consolidations.
FASB says it learned through a post-implementation review of the historical accounting standard around business combinations that the definition of a business adopted with that 2007 standard applied too broadly. That led companies following the accounting guidance to apply business combination accounting even when a particular transaction involved only the transfer of an asset or collection of assets.
The analysis can get tricky in research-intensive sectors, like pharmaceuticals or technology, where the sale of a promising research process might fall somewhere between a business or a collection of assets. In-process research and development often changes hands before a particular break-through is marketable, leading to questions about whether it’s an asset or a business when it transfers to new control.
The new guidance provides a screen, FASB says, to catch cases when a set of inputs, assets, and outputs as defined in existing GAAP does not add up to an independent business. FASB says the new framework for determining when a set of assets and activities constitutes a business will provide more consistency, reduce the cost of compliance, and make the definition of a business more operable. Earlier FASB approved a change to business combination accounting to make it easier to adjust provisional amounts in subsequent period financial statements.
Public companies are required to apply the new definition of a business in interim and annual periods that begin after Dec. 15, 2017. That gives the new definition the same effective date as the new rules on recognizing revenue. FASB says the guidance is aligned with the new revenue recognition guidance, which is expected to produce more consistent application.