Updated definition of a businessPosted: January 9, 2017
The FASB recently updated its definition of a business. Many people’s first reaction is probably, “so what, why does that matter?” It matters because you account for the sale and purchase of an asset one way, and the sale and purchase of a business in another manner. And, quite frankly, accounting for the sale and purchase of an asset is much easier. People’s second reaction is probably “come on, you mean people couldn’t tell when they were selling an asset and when they were selling a business?” The answer to that is yes. One might think that if you sell a building, you’re selling an asset, but that is not necessarily the case. There are companies that are in the business of operating buildings. They own, lease, improve and manage the buildings. Isn’t an individual building then no different from a division of a company that provides a distinct product or service?
The FASB has decided to clarify the definition of a business by making three distinct changes to the definition of a sale of a business.
- If substantially all of the fair value of the gross assets transferred is concentrated in a single asset or a group of similar identifiable assets, then the transfer if a sale of an asset and not the sale of a business.
- The transfer must include at least one substantive process to be the sale of a business. The old definition did not require the transfer to include a substantive process. Instead, under the old definition, as long as a “market participant” could add a substantive process, then the transfer was considered a business.
- The definition of a business also requires that the transfer include an “output.” That definition is now aligned with the definition in the new revenue recognition standard – that is it defines an output as “the result of inputs and processes applied to those inputs that provide goods or services to customer, investment income or other revenues.”
The result of these changes is that there will be fewer transfers accounted for as sales of a business and more transfers accounted for as sales of an asset. That is great news because it will result in simpler accounting. The rules are effective in 2018, but this is one you might want to consider adopting early because it will make your life easier.