On 22 October 2018, the IASB issued 'Definition of a Business (Amendments to IFRS 3)' aimed at resolving the difficulties that arise when an entity determines whether it has acquired a business or a group of assets. The amendments are effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after 1 January 2020.
The post-implementation review of IFRS 3 Business Combinations revealed that entities have difficulties when determining whether they have acquired a business or a group of assets. As the accounting requirements for goodwill, acquisition costs and deferred tax differ on the acquisition of a business and on the acquisition of a group of assets, the IASB decided to issue narrow scope amendments aimed at resolving the difficulties that arise when an entity is determining whether it has acquired a business or a group of assets.
The amendments in Definition of a Business (Amendments to IFRS 3) are changes to Appendix A Defined terms, the application guidance, and the illustrative examples of IFRS 3 only.
Minimum requirements to meet the definition of a business
The amendments clarify that while businesses usually have outputs, outputs are not required for an integrated set of activities and assets to qualify as a business. However, to meet the definition of a business, an integrated set of activities and assets must include, as a minimum, an input and a substantive process that together significantly contribute to the ability to create output. The IASB also clarifies that outputs in and of themselves are not sufficient to determine that an integrated set of activities and assets is a business. Instead, the entity needs to demonstrate that both an input and a substantive process have been acquired.
To clarify that a business can exist without including all of the inputs and processes needed to create outputs, the IASB replaced the term ‘ability to create outputs’ with ‘ability to contribute to the creation of outputs’.
Assessing whether an acquired process is substantive
To determine whether an acquired process is substantive, different criteria apply, depending on whether there are outputs at the acquisition date. New guidance and illustrative examples are added to help entities assess whether a substantive process has been acquired.
Market participant’s ability to replace missing elements
Before the amendments, IFRS 3 stated that a business did not need to include all of the inputs or processes that the seller used in operating the business if market participants are capable of acquiring the business and continuing to produce outputs, for example, by integrating the business with their own inputs and processes.
The IASB has now removed this reference and instead, as described above, decided to focus on whether acquired inputs and acquired substantive processes together significantly contribute to the ability to create outputs.
Narrowed definition of outputs
To narrow the definition of outputs, the IASB has amended the definition of a business in Appendix A of IFRS 3 as well as the definition of outputs in the Application Guidance to IFRS 3. These amendments put the focus of outputs on goods and services provided to customers. By that, the IASB wants to achieve consistency with the notion of outputs in IFRS 15 Revenue from Contracts with Customers.
The amendments remove from the new definitions references to returns in the form of lower costs and other economic benefits provided directly to investors or other owners, members or participants. In the IASB’s view, the reduction of costs is not a helpful concept to distinguish between acquisitions of a business and asset acquisitions. Many asset acquisitions that do not include a substantive process may also be made with the motive of lowering costs.
Optional test to identify concentration of fair value
The IASB has introduced an optional test that provides a simplified assessment of whether an acquired set of activities and assets is not a business (the concentration test). If the concentration test is met, the set of activities and assets is determined not to be a business and no further assessment is needed. If the test is not met, an entity performs the assessment set out above to determine whether or not the acquired set of activities and assets is a business.
An example of how the test is performed is added to the Illustrative Examples that accompany IFRS 3.
Interaction with the FAS
IFRS 3 and the corresponding US GAAP requirements (SFAS 141(R)) are substantially converged. With regard to the definition of a business, the PIR of SFAS 141(R) revealed similar issues as the PIR of IFRS 3. Consequently, in 2017 the US Financial Accounting Standards Board (FASB) amended US GAAP.
Although the IASB’s amendments to IFRS 3 are based on similar conclusions as the US GAAP amendments, they differ in some respects. However, the IASB expects that the amendments will lead to more consistency in applying the definition of a business across entities applying IFRS and entities applying US GAAP.
Effective date and transition requirements
The amendments are effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after 1 January 2020 and to asset acquisitions that occur on or after the beginning of that period. Earlier application is permitted.
The article is part of dReport – December 2018, Accounting news.