The definition of a business is key to how to apply certain accounting rules, but those interpreting and following the rules say the current definition applies too broadly, so the Financial Accounting Standards Board is proposing some clarifications.
The definition comes into play when companies are following accounting rules related to acquisitions, disposals, goodwill, and consolidation. FASB says stakeholders have reported that applying the current definition of a business, as spelled out in U.S. Generally Accepted Accounting Principles, ends up sweeping in transactions that don’t really fit the conventional notion of what constitutes a business.
Entities have told FASB, for example, that they end up accounting for some transactions as business combinations even when they believe what they’ve really acquired is more like an asset. FASB also hears that the transaction analysis necessary to assure compliance with the current definition is difficult and costly. Those concerns emerged foremost, in fact, when FASB’s overseer, the Financial Accounting Foundation, conducted its post-implementation review of the rules on business combinations adopted under FASB Statement No. 141R.
To address those concerns, FASB is proposing some clarifications that are intended to “provide more consistency in the application of the guidance, reduce the costs of its application, and make the definition of a business more operable,” according to FASB’s summary of the proposal.
FASB’s current definition of a business describes it based on inputs, processes, and outputs associated with a collection of assets and activities. FASB says some of the current uncertainty around how to apply the definition centers around a lack of clarity with respect to the minimum inputs and processes necessary to constitute a business.
The proposed clarification would say that in order for a set of assets and activities to form a business, there must be an input and a substantive process that together contribute to the ability to create outputs. The proposed guidance would also provide a framework for helping evaluate whether both an input and a substantive process are present.
FASB says its current definition of a business is identical to that contained in International Financial Reporting Standards. “However, the board observes that it does not appear to be interpreted or applied consistently in practice between jurisdictions that apply GAAP and those that apply IFRS,” FASB says.