As we discussed last time, 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
We ended the last post by addressing the “optional concentration test” whereby 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 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 acquisition can be assessed as one of a “group of similar identifiable assets,” and so as not being a business.
To continue with that, the IASB then tweaks the scenario so that the purchaser of that portfolio also acquires a multi-tenant corporate office park with six 10-storey office buildings that are fully leased, along with contracts for outsourced cleaning, security and maintenance. In this instance the optional test isn’t met: the risks associated with the single-family homes and the office park differ significantly. However, this still doesn’t constitute the acquisition of a business, given the absence of an organized workforce, and the minor and ancillary nature of the (easily replaced) outsourcing contracts. When the scenario is tweaked again, to include acquiring the employees responsible for leasing, tenant management, and managing and supervising all operational processes, then the analysis tips the other way, to identify a business. Of course, I’m summarizing the analysis considerably here.
The IASB has provided various other illustrative examples, all of which seem to me to be pretty clear (if anything, a lot of them may be too clear-cut to be as helpful as one might like).
It’s worth remembering that in some jurisdictions, the amended version of IFRS 3 may not be the last word on identifying a business for all corporate reporting purposes. For example, Canadian securities regulation includes a requirement to file financial statements of entities acquired in a “significant acquisition” of a business. This depends on various tests, and although in the great majority of cases the determination of whether or not a particular acquired entity is a business will fall in line with the assessment made under IFRS 3, the regulations don’t explicitly confine themselves to that. It seems possible to me that determinations made with reference to the optional concentration test will sometimes fall into the intervening grey zone. For instance, returning to the same example, a portfolio of 10 single-family homes that each have an in-place lease may not be a business for the purposes of IFRS 3, but even so, it’s not hard to see how historical financial statements for the portfolio, illustrating its revenue and related expenses and so forth, might carry meaningful predictive value for an investor. We’ll have to see if any gap opens up in such instances.
Of course, the major underlying point of all this is that the accounting for a business acquisition may include recognizing goodwill, whereas that for an asset acquisition doesn’t. In plain language terms, that’s because a business amounts to more than the sum of its parts, where an asset acquisition is just a collection of parts. In a perfectly rational world, the fair value assigned to (say) an acquired patent would presumably be the same whether it’s acquired in conjunction with a bunch of other intangibles, or whether it’s acquired as part of a business: either way, it’s the same item. In practice, though, the assigned fair value is often higher in the former situation, because in the absence of goodwill, there’s nowhere else for the “excess” purchase price to go. For example, an entity that might measure such an item at the mid-point of an indicated range of values if it’s acquired in a business combination might end up measuring it at the high end of the range if it’s acquired in an asset acquisition. All this really means is that the consideration paid in such transactions often isn’t rational, especially when issued in shares. To that extent, the carrying values of goodwill and of intangible assets are often likely to be viewed by users with equal skepticism and as carrying largely equal information content, thus blunting the practical difference between a business and an asset acquisition.
Another prominent difference relates to the treatment of acquisition-related costs – in a business combination they’re expensed as incurred, but in an asset acquisition they’re capitalized as part of the carrying value. The basis for conclusions acknowledges this inconsistency, but indicates that the IASB put more weight on eliminating previously-existing inconsistencies in accounting for acquisition-related costs in connection with a business combination, and on applying the fair value measurement principle to all such combinations. However, in cases where the difference between a business and an asset acquisition is fairly subtle, again perhaps in some fact patterns resolved by applying the optional concentration test, it doesn’t seem logical that the consequential impact on the current year’s income statement might be materially different. Still, that’s not likely to change in the foreseeable future…
The opinions expressed are solely those of the author