“I’m not a businessman, I’m a business, man!” – Jay-Z
The Financial Accounting Standards Board’s (FASB) definition of a business is important when it comes to classifying assets and related expenses. If the target of an acquisition is classified as a business, the acquiring company is required to recognize acquisition expenses immediately as well as measure the fair value of all assets acquired (including goodwill and intangible assets). If the acquisition is classified as a group of assets instead, the acquiring company can capitalize the acquisition expenses and a purchase price allocation would not be required. However, some feel that the FASB’s current definition is ambiguous and can result in inconsistent designations of business or asset status.
In November 2015, the FASB proposed a standards update to clarify the assets versus business debate. Under the existing definition included in ASC 805, a “set of assets and activities” is considered a business if it has three characteristics – inputs (intangible assets, IP, access to materials or employees), processes (systems that “have the ability to create outputs”), and outputs (goods, services, revenue, or investment income). However, a set is not required to have outputs to be defined as a business. Additionally, ASC 805 does not set minimum standards as to what constitutes inputs and processes, and potentially allowed for a set to be classified as a business even if processes needed to be supplied or replaced by the acquirer. Together, it has been suggested that these issues complicated companies’ abilities to distinguish their acquisitions with certainty.
Under the proposed revision as laid out in the exposure draft, an evaluation of the acquirer’s ability to create outputs or replace missing inputs or processes would not be required, and the set would be evaluated on an as-is basis. Rather than looking at the set’s ability to produce outputs when combined with the acquirer’s existing resource, the revised ASC 805 would consider the set’s production of outputs on its own. The revised rule would place more weight on the “reasonable judgment” of the parties involved and its aim is to result in more consistent definitions of business and asset acquisitions.
In practice, if the revised rule is adopted by the FASB, the financial reporting burden for acquiring companies could be reduced. CFOs would have an easier time classifying their acquisitions, potentially leading to savings of both time and expense. The ability to capitalize expenses and delay recognition of transaction costs would certainly be more favorable to near-term earnings. However, the degree to which this change impacts companies is obviously tied to the frequency with which the issue arises in the first place. In our experience, most asset acquisitions occur with respect to purchases of standalone intellectual property (such as a piece of software or a patent), a collection of customer or supplier contracts (without the requisite employees or business processes), or a piece of machinery or equipment.
Comments on the exposure draft were accepted through January 22, 2016. The FASB does not currently have an expected decision date for the revision but we will continue to monitor developments around this issue.
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- Purchase Price Allocations and the PCC