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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.