Clarifying the Definition
of a Business
Valuation Vantage
Fall 2016 | 4
On November 23, 2015, the FASB issued a proposed Accounting
Standards Update (“ASU”) under ASC 805 that clarifies the
definition of a business.
BACKGROUND
The current definition of a business is commonly critiqued as
being too broad, resulting in many asset acquisitions falsely
qualified as businesses. Analyzing transactions under the
current definition is difficult and costly, and does not always
permit the use of reasonable judgment.
MAIN PROVISIONS OF NEW PROPOSED ASU
As defined under the proposed ASU, a business is an integrated
set of activities and assets capable of being conducted and
managed to provide a return in the form of dividends, lower
costs, or other economic benefits directly to investors or other
owners, members or participants. In other words, a business
includes at a minimum an input and substantive process that
together create outputs. The proposed ASU would remove the
need to evaluate whether a market participant, such as a buyer
or investor, could replace any missing elements of a business.
The three elements of a business are defined below:
1. Inputs - Any economic resource that creates, or has the
ability to create, outputs when one or more processes
are applied to it. Examples include long-lived assets
(including intangible assets or rights to use long-lived
assets), intellectual property, the ability to obtain access
to necessary materials or rights, and employees.
2. Process - Any system, standard, protocol, convention,
or rule that when applied to an input or inputs,
creates or has the ability to create outputs. Examples
include strategic management processes, operational
processes, and resource management processes. These
processes typically are documented, but an organized
workforce having the necessary skills and experience
following rules and conventions may provide the
necessary processes that are capable of being applied to
inputs to create outputs. Accounting, billing, payroll,
and other administrative systems typically are not
processes used to create outputs.
3. Output - The result of inputs and processes applied to
those inputs that provide goods or services to customers,
other revenues, or investment income, such as dividends or
interest.
In addition to the new business definition, the proposed ASU
addresses the following issues in ASC 805:
1. A set that does not have outputs - When a set does not
have outputs (for example, an early stage company that has
not generated revenues), the set would have both an input
and a substantive process that together contribute to the
ability to create outputs if it includes an organized workforce
that has the necessary skills, knowledge, or experience to
perform an acquired process (or group of processes) that,
when applied to another acquired input or inputs, is critical
to the ability to develop or convert that acquired input or
inputs into outputs. An entity should consider the following
in evaluating whether the acquired workforce is performing
a substantive process:
a. A process (or group of processes) is not critical if
it is considered ancillary or minor in the context of
all the processes required to create outputs.
b. Inputs that the organized workforce could develop
(or is developing) or convert into outputs could
include the following:
i. Intellectual property that could be used
to develop a good or service
ii. Resources that could be developed to
create outputs
iii. Access to necessary materials or rights
that enable the creation of future outputs.