The IASB has issued Definition of a Business, amendments to IFRS 3, effective for transactions for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after January 1, 2020
Prior to the amendments, IFRS 3 defines a business as “an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs or other economic benefits directly to investors or other owners, members or participants.” Following the Post-implementation Review of IFRS 3, the Board concluded in 2015 that many stakeholders have concerns about how to interpret and apply this definition. Among other things, problems arise from its inherent broadness; in assessing the relevance of the processes acquired as part of the acquired set of activities and assets, and the significance of the processes missing from the set; and in applying the definition when the entity acquired doesn’t generate revenues. The amendments are intended to bring greater clarity to the concept.
The new definition is this:
- An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing goods or services to customers, generating investment income (such as dividends or interest) or generating other income from ordinary activities”
The change reflects in part that an acquired asset might also provide a return in the form of lower costs or other economic benefits, so the old wording didn’t directly help in drawing a clear distinction.
The standard currently explains that a business “consists of inputs and processes applied to those inputs that have the ability to create outputs. Although businesses usually have outputs, outputs are not required for an integrated set to qualify as a business.” This will now read as follows:
- A business consists of inputs and processes applied to those inputs that have the ability to contribute to the creation of outputs.
It should be clearer in the revised definition that a business can exist without including all of the inputs and processes needed to create outputs, or of course without including the outputs themselves. Digging further into that: to be considered a business, an integrated set of activities and assets must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs. This is where the amendments introduce a lot of detail, for instance:
- If a set of activities and assets does not have outputs at the acquisition date, an acquired process (or group of processes) shall be considered substantive only if: (a) it is critical to the ability to develop or convert an acquired input or inputs into outputs; and (b) the inputs acquired include both an organized workforce that has the necessary skills, knowledge, or experience to perform that process (or group of processes) and other inputs that the organized workforce could develop or convert into outputs. Those other inputs could include: (i) intellectual property that could be used to develop a good or service; (ii) other economic resources that could be developed to create outputs; or (iii) rights to obtain access to necessary materials or rights that enable the creation of future outputs.
An organized workforce is usually key to identifying a business then. However, the IASB does carve out the situation where the acquired set already has outputs, and includes a process (or group of processes) that’s unique or scarce, or can’t be replaced without significant cost, effort, or delay in producing outputs: this would often indicate that the processes are substantive, even if no organized workforce is acquired.
Here are some other factors relevant to assessing whether an acquired process is substantive:
- an acquired contract is an input and not a substantive process. Nevertheless, an acquired contract, for example, a contract for outsourced property management or outsourced asset management, may give access to an organized workforce, and therefore to a substantive process that the entity controls. This would be assessed based on such factors as the contract’s duration and renewal terms.
- difficulties in replacing an acquired organized workforce may indicate that the acquired workforce performs a process that is critical to the ability to create outputs.
- a process (or group of processes) is not critical if, for example, it’s ancillary or minor within the context of all the processes required to create outputs.
On top of all that, the amendments include an “optional concentration test,” to permit a simplified assessment of whether an acquired set of activities and assets is not a business (one’s heart may sink a bit at this, given how the term “optional concentration test” carries connotations of regulatory cookbooks – such as the “optional significance tests” contained in Canadian securities regulation – rather than of principles). The notion here is that if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, then the acquired assets and activities may be determined – regardless of any other considerations – not to be a business. For instance, the illustrative examples provide a scenario of “a portfolio of 10 single-family homes that each have an in-place lease” in which, given the similarity of the underlying assets and the attached risks, the transaction can be assessed as acquiring a “group of similar identifiable assets,” rather than as acquiring a business.
More on the IFRS 3 amendments next time.
The opinions expressed are solely those of the author