Chapter 2 — Identifying a Business Combination

2.4 Definition of a Business

In January 2017, the FASB issued ASU 2017-01 to clarify the guidance in ASC 805-10 on evaluating whether a transaction should be accounted for as an acquisition (or disposition) of assets or a business. The FASB issued the ASU in response to stakeholder feedback indicating that the previous deﬁnition of a business in ASC 805-10 was being applied too broadly and was difficult and costly to apply. The amendments to ASC 805-10 were intended to make the application of the guidance more consistent and cost-efﬁcient. As expected at the time of ASU 2017-01’s issuance, some transactions that would have been accounted for as business combinations under previous guidance are being accounted for as asset acquisitions under ASU 2017-01. See Appendix C of this Roadmap for more information about accounting for asset acquisitions, including the differences between such accounting and the accounting for business combinations.

Under the clarified definition of a business, entities use the screen as described in ASC 805-10-55-5A through 55-5C, to determine whether an acquired set of assets and activities is not a business. In accordance with ASU 2017-01, if “substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business.” If such a concentration is not found, the screen is not met and entities must then apply the framework discussed in Section 2.4.3 to determine whether the set is a business.

Distinguishing between the acquisition of a business and the acquisition of an asset or a group of assets is important because there are many differences between the accounting for each. For example, in a business combination, the assets acquired are recognized at fair value and goodwill is recognized, whereas in an asset acquisition, the cost of the acquisition is allocated to the assets acquired on a relative fair value basis and no goodwill is recognized. See Section C.1.1 for a summary of the differences between the accounting for a business combination and the accounting for an asset acquisition.

SEC Considerations

SEC registrants are required to use the definition of a business in SEC Regulation S-X, Rule 11-01(d), when evaluating the requirements of SEC Regulation S-X, Rule 3-05, and SEC Regulation S-X, Article 11. The definition of a business in Rule 11-01(d) is different from that in ASC 805-10. See Section 2.1 of Deloitte’s Roadmap SEC Reporting Considerations for Business Acquisitions for more information about the definition of a business in Rule 11-01(d) and related reporting requirements for SEC registrants.

The flowchart below outlines the application of the FASB’s guidance on the definition of a business.

2.4.1 Identifying the Activities and Assets of the Acquired Set

To evaluate whether an acquired set of activities and assets meets the definition of a business, an entity must first identify the set (i.e., what is being exchanged). While the identification of the acquired set is relatively straightforward in most acquisitions, judgment may be required in some, as discussed below.

2.4.1.1 Employees of the Seller

In some acquisitions, the acquirer obtains control of a legal entity from the seller, and any employees of that legal entity become employees of the acquirer. In these acquisitions, the acquirer obtains an organized workforce that is expected to be included in the acquired set.

In other acquisitions, the acquirer obtains control of an asset or a group of assets, rather than a legal entity, and it must separately hire the employees of the seller after the acquisition if it seeks to obtain their services. We believe that in such a case, the determination of whether the acquired set includes those employees should be based on an evaluation of all relevant facts and circumstances and that such employees should not be presumptively excluded from the set on the basis of the legal form of the transaction. Employees of the seller are more likely to be included in the acquired set when hired in close proximity to the transaction date and when the seller is involved in facilitating the acquirer’s hiring of the employees, as might be the case if such hiring is a condition of the closing.

2.4.1.2 Contractual Arrangements Between the Acquirer and a Party Other Than the Seller

Contractual arrangements that are separately negotiated between the acquirer and a party other than the seller typically are not considered part of the acquired set even if they are entered into at or around the time of the acquisition or are contingent on the acquisition. In addition, certain contractual arrangements, even if assumed in the acquisition, might be excluded from the acquired set when there is substantial involvement of the acquirer in initiating or modifying the contract that is contingent on the acquisition such that the contract is effectively between the acquirer and a party other than the seller.

2.4.1.3 Revenue Arrangements With the Seller

In some acquisitions, the buyer and seller may enter into revenue arrangements at the time of, or in close proximity to, the acquisition date that will take effect on or after the acquisition date. Paragraph BC54 of ASU 2017-01 clarifies that “[t]he Board decided to specifically exclude those revenue arrangements from the analysis of whether a substantive process has been acquired. That is, the Board decided that a set is not a business just because there is a contract that provides a continuing revenue stream.”

2.4.1.4 Transactions That Are Separate From the Business Combination

As part of its accounting for an acquisition, an acquirer must assess whether the items exchanged include amounts that should be accounted for separately from the business combination. Transactions that are determined to be separate from the business combination should be excluded from the acquired set. See Section 6.2 for more information.

2.4.2 Single or Similar Assets

ASC 805-10

55-5A 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, the set is not considered a business. Gross assets acquired should exclude cash and cash equivalents, deferred tax assets, and goodwill resulting from the effects of deferred tax liabilities. However, the gross assets acquired should include any consideration transferred (plus the fair value of any noncontrolling interest and previously held interest, if any) in excess of the fair value of net identifiable assets acquired.

Once an entity has identified the acquired set, it then evaluates whether that set is not a business on the basis of the screen in ASC 805-10-55-5A through 55-5C. As noted above, under the screen, “[i]f substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not considered a business.” An entity can evaluate whether the screen is met by applying the following steps:

Step 1 — Combine the identifiable assets into a single identifiable asset.
Step 2 — Combine the assets into similar assets.
Step 3 — Measure the fair value of the gross assets acquired.
Step 4 — Determine whether substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets.

An entity must apply the recognition and measurement guidance for business combinations in ASC 805-10, ASC 805-20, and ASC 805-30 (including any recognition or measurement exceptions) to perform the screen; however, if the entity determines that the acquired set is not a business, it should recognize and measure the assets (and liabilities) in its financial statements by using the principles in ASC 805-50 (or the guidance in ASC 810-10-30-3 and 30-4 if the entity is a VIE). See Appendix C for more information about accounting for asset acquisitions, including potential differences in the recognition and measurement of acquired assets.

2.4.2.1 Step 1 — Combine the Identifiable Assets Into a Single Identifiable Asset

ASC 805-10

55-5B A single identifiable asset includes any individual asset or group of assets that could be recognized and measured as a single identifiable asset in a business combination. However, for purposes of this evaluation, the following should be considered a single asset:

A tangible asset that is attached to and cannot be physically removed and used separately from another tangible asset (or an intangible asset representing the right to use a tangible asset) without incurring significant cost or significant diminution in utility or fair value to either asset (for example, land and building)
In-place lease intangibles, including favorable and unfavorable intangible assets or liabilities, and the related leased assets.

The FASB notes in paragraph BC24 of ASU 2017-01 that “[f]or ease of application, the Board decided that an entity should use the same unit of account when assessing the [screen] that it would use for identifying assets recognized in a business combination even if it results in some tangible assets and intangible assets being combined into a single asset.” The FASB reasoned that the assessment related to the screen should not result in significant incremental costs for acquisitions because entities must determine the fair value of each asset in both asset acquisitions and business combinations.

ASC 805 provides no specific guidance on determining the unit of account for identifiable assets, but it offers the following three examples of acquired assets that may be recognized as a single asset in financial reporting:

“[A] group of complementary assets such as a trademark (or service mark) and its related trade name, formulas, recipes, and technological expertise.” (See ASC 805-20-55-18.)
A license to operate a nuclear power plant and the power plant. (See ASC 805-20-55-2(b).)
An artistic-related copyright “and any related assignments or license agreements.” (See ASC 805-20-55-30.)

In each example, the assets that are combined for financial reporting have similar useful lives. In addition, we believe that to be combined into a single unit of account, the assets should have similar methods of amortization, since this would ensure that they have a similar effect on financial reporting. Determining whether it is appropriate to combine assets into a single unit of account may require considerable judgment, particularly when it comes to combining tangible and intangible assets. See Section 4.10.3 for more information about determining the unit of account.

While entities should generally apply the same unit of account when both performing the evaluation required by the screen and recognizing assets in a business combination, ASC 805-10-55-5B provides two exceptions. The first exception requires entities to combine “[a] tangible asset that is attached to and cannot be physically removed and used separately from another tangible asset (or an intangible asset representing the right to use a tangible asset) without incurring significant cost or significant diminution in utility or fair value to either asset.” In paragraph BC23 of ASU 2017-01, the FASB notes that it permitted this exception because without it, “the [screen] could not be applied practically in certain circumstances, such as in the real estate industry where land and buildings are often transferred together.”

As indicated in ASC 805-10-55-5B(b), the second exception requires entities to combine “[i]n-place lease intangibles, including favorable and unfavorable intangible assets or liabilities, and the related leased assets.” This exception was primarily intended to increase consistency in the accounting for real estate transactions by reducing the likelihood that an acquisition would be accounted for as a business combination simply because a lease was in a sought-after location and had significant in-place value or because a lease had above- or below-market rents.

We do not believe that entities should combine other assets by analogy to these exceptions in ASC 805-10-55-5B. For example, it would not be appropriate to combine a hotel and its related brand name or to combine a wind or solar farm and a related power purchase agreement if the power purchase arrangement does not meet the definition of a lease.

Entities should combine identifiable assets that meet the exceptions (e.g., land and building or in-place lease intangible asset and the related leased assets) only when evaluating the screen; for other purposes, such assets typically should be recognized separately regardless of whether the acquired set is a business or a group of assets. For example, while a building and an in-place lease would be combined in the evaluation required by the screen, they would be recognized separately for financial reporting purposes.

As indicated in ASC 805-10-55-5B, a “single identifiable asset includes any individual asset or group of assets that could be recognized and measured as a single identifiable asset in a business combination.” After the adoption of ASC 842, right-of-use (ROU) lease assets are recognized as identifiable assets and, therefore, should be included in the performance of the screen test under ASC 805-10-55-5B. See Section 4.3.11 for additional considerations related to the accounting for leases acquired in a business combination.

The table below summarizes the examples in ASC 805-10-55-52 through 55-87 (see Section 2.4.4), which illustrate scenarios in which an entity analyzes whether to combine assets into a single identifiable asset.

Case	Facts	Can Some or All of the Identifiable Assets Be Combined Into a Single Identifiable Asset?
Case A: Acquisition of Real Estate (Scenario 1 in ASC 805-10-55-52 through 55-54)	Acquisition of a portfolio of single-family homes that each have an in-place lease. Each single-family home includes the land, building, and property improvements.	Yes. The building and property improvements are attached to the land, and the entity cannot remove them without incurring significant cost. The in-place lease is an intangible asset that should be combined with the related real estate asset and considered a single asset.
Case B: Acquisition of a Drug Candidate (Scenario 1 in ASC 805-10-55-65 and 55-66)	Acquisition of a biotech entity that contains the rights to a phase 3 compound. Included in the IPR&D project is the historical know-how, formula protocols, designs, and procedures expected to be needed to complete the related phase of testing.	Yes. The IPR&D is an identifiable asset that would be accounted for as a single asset.
Case D: Acquisition of a Television Station (ASC 805-10- 55-73 through 55-76)	Acquisition of an FCC license, broadcasting equipment, and an office building.	No. The acquired assets cannot be combined into a single asset in accordance with the guidance in ASC 805-10-55-5B(a).
Case E: Acquisition of a Manufacturing Facility (ASC 805-10- 55-77 through 55-81)	Acquisition of idled equipment and facility (land and buildings).	No. The equipment and facility cannot be combined into a single asset in accordance with the guidance in ASC 805-10-55-5B(a).
Case G: Acquisition of Brands (ASC 805-10-55-85 through 55-87)	Acquisition of intellectual property (the trademark, related trade name, and recipes), customer contracts and relationships, finished goods inventory, supply contracts, and equipment.	Yes. The intellectual property associated with the brand (i.e., the trademark, the related trade name, and recipes) is determined to be a single intangible asset in accordance with the guidance in ASC 805-20-55-18.

2.4.2.2 Step 2 — Combine the Assets Into Similar Assets

ASC 805-10

55-5C A group of similar assets includes multiple assets identified in accordance with paragraph 805-10-55-5B. When evaluating whether assets are similar, an entity should consider the nature of each single identifiable asset and the risks associated with managing and creating outputs from the assets (that is, the risk characteristics). However, the following should not be considered similar assets:

A tangible asset and an intangible asset
Identifiable intangible assets in different major intangible asset classes (for example, customer-related intangibles, trademarks, and in-process research and development)
A financial asset and a nonfinancial asset
Different major classes of financial assets (for example, accounts receivable and marketable securities)
Different major classes of tangible assets (for example, inventory, manufacturing equipment, and automobiles)
Identifiable assets within the same major asset class that have significantly different risk characteristics.

In accordance with ASC 805-10-55-5C, if the acquired set includes multiple assets, entities should combine the assets that qualify for combination as similar assets. Paragraph BC28 of ASU 2017-01 states, in part:

If an entity acquires, for example, multiple versions of substantially the same asset type instead of precisely one asset, the Board noted that should not disqualify the acquired items from being considered assets. The Board added that this could help alleviate pressure around what is a single asset because some stakeholders may conclude that they will be required to separate what is typically a single unit of account into multiple units of account (for example, separating a customer list into 1,000 different assets because there are 1,000 different customers).

Although the FASB does not define the term “similar” in ASC 805-10-55-5C, the guidance provides examples of assets that cannot be considered similar. For example, entities cannot combine financial assets with nonfinancial assets or tangible assets with intangible assets. However, assets that are combined under ASC 805-10-55-5B into a single identifiable asset can continue to be combined. For example, if entities combine a building and an in-place lease intangible asset into a single identifiable asset in step 1, they can continue to combine those assets in applying this step even though tangible and intangible assets cannot be combined into similar assets.

In addition, different major classes of the following asset types cannot be combined into similar assets:

Identifiable intangible assets (e.g., customer-related intangibles, trademarks, and IPR&D).
Financial assets (e.g., accounts receivable and marketable securities).
Tangible assets (e.g., inventory, manufacturing equipment, and automobiles).

Entities may need to use judgment when determining whether financial assets, tangible assets, or intangible assets are in the same major class of asset. The ASC master glossary defines an intangible asset class as “[a] group of intangible assets that are similar, either by their nature or by their use in the operations of an entity,” and ASC 350-30-50-1 requires entities to provide disclosures about the amounts assigned to each major intangible asset class. Accordingly, while the FASB does not specifically define major classes of tangible assets and financial assets, we believe that an entity performing the screen should consider the definition of intangible asset class as well as its ASC 350-30 disclosures when assessing its major classes of assets.

Further, ASC 805-10-55-5C states that entities cannot combine identifiable assets within the same major asset class if the assets have “significantly different risk characteristics.” Paragraph BC31 of ASU 2017-01 states, in part:

The Board clarified that the risks to be evaluated should be linked to the risks associated with the management of the assets and creation of outputs because this assessment may be instructive on whether an integrated set of assets and activities has been acquired. That is, when the risks associated with managing and creating outputs from the assets are significantly different, the set would need more sophisticated processes to manage and create outputs.

Entities in different industries are typically affected by different types of risks. For example, in the real estate industry, entities may consider risk characteristics associated with the type of property (e.g., commercial vs. residential), size (e.g., single tenant vs. multitenant), geographic location (e.g., high-growth areas vs. low-growth areas), and class of customer (e.g., high default-risk tenants vs. low default-risk tenants). By contrast, in the life sciences industry, entities may evaluate risk characteristics associated with the stage of drug development (e.g., compounds in early development stages vs. later stages), class of customer (e.g., compounds that treat one medical condition vs. another medical condition), and market risk (e.g., products for use in the United States vs. outside the United States). Entities should consider all relevant facts and circumstances in making their determination.

The table below summarizes the examples in ASC 805-10-55-52 through 55-92 (see Section 2.4.4), which illustrate scenarios in which an entity analyzes whether assets are similar.

Case	Facts	Can Some or All of the Identifiable Assets Be Combined as Similar Assets?
Case A: Acquisition of Real Estate (Scenario 1 in ASC 805-10-55-52 through 55-54) (Scenario 2 in ASC 805-10-55-55 through 55-61)	Acquisition of a portfolio of single-family homes that all have in-place leases. Each home has a different floor plan, square footage, lot, and interior design.	Yes. The risks associated with operating the properties and managing and acquiring tenants are not significantly different.
	Acquisition of a portfolio of single-family homes and an office park with multiple office buildings.	No. The risks associated with operating the assets and obtaining and managing tenants are significantly different for the single-family homes and the office park.
Case B: Acquisition of a Drug Candidate (Scenario 2 in ASC 805-10-55-67 through 55-69)	Acquisition of a biotech entity with two IPR&D projects that are in different phases of development and that would treat significantly different medical conditions.	No. The two IPR&D projects are not similar assets because each has significantly different risks associated with creating outputs and with developing and marketing the compound to customers (i.e., the projects are intended to treat significantly different medical conditions, and each project has a significantly different potential customer base and different expected market and regulatory risks).
Case C: Acquisition of Biotech (ASC 805-10-55-70 through 55-72)	Acquisition of a biotech entity with several IPR&D projects that are in different phases of the FDA approval process and that would treat significantly different diseases.	No. The IPR&D projects are not similar assets because each has significantly different risks associated with managing the assets and creating the outputs (i.e., there are significantly different development risks, because of the different phases of development, and market risks, because of the different customer bases and potential markets for the compounds).
Case D: Acquisition of a Television Station (ASC 805-10- 55-73 through 55-76)	Acquisition of an FCC license, broadcasting equipment, and an office building.	No. The acquired assets are not similar assets because the FCC license cannot be considered similar to the tangible assets and the tangible assets are in different major asset classes.
Case E: Acquisition of a Manufacturing Facility (ASC 805-10- 55-77 through 55-81)	Acquisition of idled equipment and facility (land and buildings).	No. The acquired assets are not similar assets because the manufacturing equipment and facility are in different major classes of tangible assets.
Case F: License of Distribution Rights (ASC 805-10-55-82 through 55-84)	Acquisition of distribution rights, customer contracts, and an at-market supply agreement.	No. The acquired assets that have fair value assigned to them (e.g., the distribution license and customer contracts) are not considered similar assets because they are in different major classes of identifiable intangible assets.
Case H: Acquisition of Loan Portfolio (Scenario 1 in ASC 805-10-55-88 and 55-89) (Scenario 2 in ASC 805-10-55-90 through 55-92)	Acquisition of a portfolio of residential mortgage loans.	Yes. The loans represent similar assets because their terms, sizes, and risk ratings are not significantly different and thus the risks associated with managing and creating outputs are not significantly different.
	Acquisition of a portfolio of commercial loans.	No. The loans do not represent similar assets because their terms, sizes, and risk ratings are significantly different, and therefore the risks associated with managing them and creating outputs are significantly different.

2.4.2.3 Step 3 — Measure the Fair Value of the Gross Assets Acquired

The measurement of the fair value of gross assets acquired, which is used in determining whether substantially all of the fair value is concentrated in a single identifiable asset or group of similar identifiable assets, includes any noncontrolling interests in a partial acquisition and any previously held interests in a step acquisition. Specifically, the measurement will include (1) any consideration transferred in excess of the fair value of the net identifiable assets acquired (i.e., goodwill in a business combination) and (2) any value attributable to an assembled workforce (since it is subsumed into goodwill). For the purpose of this calculation, the consideration transferred should include all forms of consideration, such as cash, contingent consideration, or other applicable forms as discussed in ASC 805-30-30-7.

The measurement of gross assets acquired excludes cash and cash equivalents (including restricted cash), deferred tax assets, and goodwill resulting from the effects of deferred tax liabilities. As stated in paragraph BC27 of ASU 2017-01:

The Board concluded that deferred taxes should be excluded from the evaluation of the [screen]. That is, any value associated with deferred tax assets and the effects of deferred tax liabilities on gross assets would be excluded from gross assets acquired. The Board reasoned that the tax form of the transaction that often dictates the amount of deferred taxes in the transaction should not affect the determination of whether the transaction is a business.

In addition, as described in Section 2.4.1.4, entities should exclude any amounts related to transactions that are separate from the acquisition (e.g., arrangements that represent compensation for future services).

With the exception of unfavorable lease liabilities that are combined with the related leased asset under ASC 805-10-55-5B(b), the calculation of gross assets acquired excludes debt and other liabilities. Paragraph BC20 of ASU 2017-01 states that “[t]he Board reached this conclusion to avoid the existence of debt (for example, a building with a mortgage) or other liabilities affecting the analysis of whether the [screen] has been met. That could potentially result in a group of assets that would otherwise be subject to further evaluation under the model bypassing such evaluation solely because a transaction includes liabilities in addition to assets.”

The requirement to exclude liabilities also applies to asset retirement obligations (AROs) related to assets included in the acquired set. For example, assume that Company A acquires Company B, a utility, in a transaction that is accounted for as a business combination. Company A determines that an ARO exists related to B’s facility and estimates the ARO’s fair value to be $25 million. Company A estimates the fair value of the facility to be $100 million, meaning that the value of the facility would be $25 million higher if the costs associated with the ARO were ignored. Accordingly, in determining the single identifiable asset or similar assets and the gross assets acquired, A would use $125 million. See Section 4.8.1 for more information about assets subject to AROs.

ASC 805-10-55-5A states that gross assets “should include any consideration transferred . . . in excess of the fair value of net identifiable assets acquired,” but it does not address whether the screen should include any deficit (i.e., bargain purchase gains). We believe that bargain purchase gains should be excluded from the screen because their inclusion would distort the calculation in a manner similar to the inclusion of liabilities.

2.4.2.4 Step 4 — Determine Whether Substantially All of the Fair Value of the Gross Assets Acquired Is Concentrated in a Single Identifiable Asset or Group of Similar Identifiable Assets

The term “substantially all” is used throughout GAAP (e.g., in ASC 810, ASC 606, and ASC 842) and is generally interpreted to mean 90 percent or more. However, the FASB did not intend that entities treat the term as a bright line; thus, judgment must be applied in circumstances in which the quantitative result of the screen is close to 90 percent. In such cases, entities might consider other evidence to support their evaluation. For example, the following may be indicators that a set is a business:

The set includes many different types of assets (whereas a set with only a few assets may be more indicative of a group of assets).
The set includes an organized workforce or other substantive processes.
The set has outputs.
The set includes a significant amount of goodwill.
The set can operate independently on a stand-alone basis.

If the quantitative result is close to 90 percent, the presence of one or more of these indicators might warrant a determination that the screen is not met. In that case, entities should apply the framework to determine whether the set is a business.

Entities may be able to perform the screen qualitatively or bypass it in certain circumstances. See Section 2.4.2.6 for more information.

2.4.2.5 Illustration of the Screen

The example below illustrates how the steps described above are used in the screen.

Example 2-1

Company A acquires Company B for $5 million in a nontaxable acquisition. Company B is in the real estate industry and owns an apartment complex. As part of the transaction, A assumes a property management contract that was in place between B and a third-party property manager for three years before the acquisition. The pricing of the property management contract is favorable to A in terms of current market rates. Company A measures and recognizes the assets acquired and liabilities assumed at fair value as follows:

Step 1

Company A applies step 1 (see Section 2.4.2.1) and determines that the building, land, and in-place lease intangible asset are identifiable assets that qualify for combination into a single identifiable asset as follows:

Step 2

Company A applies step 2 (see Section 2.4.2.2) and concludes that none of the remaining assets (i.e., cash, furniture or fixtures, or the intangible asset for the favorable property management contract) qualify for combination as similar assets under ASC 805-10-55-5B.

Step 3

Company A applies step 3 (see Section 2.4.2.3) and concludes that the gross assets acquired include any consideration transferred in excess of the fair value of the net identifiable assets acquired (i.e., goodwill in a business combination), but it does not include goodwill that results from the effects of deferred tax liabilities, cash and cash equivalents, deferred taxes, or liabilities. Company A calculates the fair value of gross assets acquired as follows:

Step 4

Company A applies step 4 (see Section 2.4.2.4) and compares the fair value of the single identifiable asset (or group of similar assets), measured in step 2, to the fair value of the gross assets acquired, measured in step 3.

While “substantially all” is generally interpreted to mean 90 percent or more in the definition of a business, it is not a bright line. Since 90.4 percent is only slightly above 90 percent, A might consider the qualitative factors in assessing whether the screen has been met.

For example, A might consider the nature of the acquired assets and liabilities, all of which are directly related to the apartment complex. Although A did not acquire any employees, it might consider whether the property management contract it obtained gives it access to an organized workforce, which could be an indicator that A has acquired a substantive process. In this case, A concludes that the contract is not unique or scarce and could be replaced without significantly delaying its ability to continue earning revenues. However, it decides not to replace the property manager because the pricing in the contract is favorable to A compared with the pricing it would be able to obtain on the acquisition date. In addition, A notes that if it had assumed that the acquisition were a business, the amount of goodwill measured would not be a significant amount. Company A believes that the qualitative factors support a determination that the screen is met and that the transaction is an asset acquisition.

2.4.2.6 Assessing the Screen Qualitatively

In some instances, an entity may be able to determine that the screen has been met solely on the basis of qualitative factors. For example, if the acquisition includes a license for a drug candidate and an at-market contract that would have no fair value assigned to it, it may be clear that the screen has been met. By contrast, an entity may often be able to qualitatively determine that the screen has not been met if there is clearly significant value in assets that are not similar. Paragraph BC19 of ASU 2017-01 states, in part:

In addition, an entity also could conclude that the set is not a business by assessing the guidance in paragraphs 805-10-55-5D through 55-6 and 805-10-55-8 through 55-9. The Board noted that if the set is not a business, an entity could choose to document its conclusion in the most cost-effective manner depending on its situation. [Emphasis added]

Therefore, entities may bypass the screen and proceed directly to the framework (see Section 2.4.3) as long as the set is determined not to be a business under the framework. However, entities may not bypass the screen and apply the framework to conclude that a set is a business since that determination may contradict the conclusion that would have been made by applying the screen.

2.4.3 Framework for Assessing Whether an Input and a Substantive Process Are Present

ASC 805-10

55-5 To be capable of being conducted and managed for the purposes described in paragraph 805-10-55-3A, an integrated set of activities and assets requires two essential elements — inputs and processes applied to those inputs. A business need not include all the inputs or processes that the seller used in operating that business. However, to be considered a business, the set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output. Paragraphs 805-10-55-5A through 55-5C provide a practical screen to determine when a set would not be considered a business. If the screen is not met, further assessment is necessary to determine whether the set is a business. Paragraphs 805-10-55-5D through 55-6 and 805-10-55-8 through 55-9 provide a framework to assist an entity in evaluating whether the set includes both an input and a substantive process.

55-8 Determining whether a particular set of assets and activities is a business should be based on whether the integrated set is capable of being conducted and managed as a business by a market participant. Thus, in evaluating whether a particular set is a business, it is not relevant whether a seller operated the set as a business or whether the acquirer intends to operate the set as a business.

If the screen is not met, entities must determine whether the acquired set includes, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs. ASC 805-10-55 provides a framework for making that judgment.

The assessment of whether a set meets the definition of a business under the framework should be based on whether a market participant would be capable of conducting and managing the set as a business. Neither how the seller operated the set nor how the acquirer intends to operate it is relevant in making the determination. For example, if an acquirer obtains a set with operations that are similar to its own, its plans to integrate the set into its operations and use its own processes to continue the production of outputs are not relevant in the determination of whether a substantive process was acquired.

ASU 2017-01 eliminated the need to assess whether a market participant is capable of replacing any missing elements to continue the production of outputs. Therefore, entities must now focus their analysis on what was acquired and no longer on whether a market participant could potentially replace missing elements.

2.4.3.1 Identify the Elements of a Business

ASC 805-10

55-3A A business is 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. To be considered a business, an integrated set must meet the requirements in paragraphs 805-10-55-4 through 55-6 and 805-10-55-8 through 55-9.

55-4 A business consists of inputs and processes applied to those inputs that have the ability to contribute to the creation of outputs. Although businesses usually have outputs, outputs are not required for an integrated set to qualify as a business. The three elements of a business are defined as follows:

Input. Any economic resource that creates, or has the ability to contribute to the creation of, 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.
Process. Any system, standard, protocol, convention, or rule that when applied to an input or inputs, creates or has the ability to contribute to the creation of outputs. Examples include strategic management processes, operational processes, and resource management processes. These processes typically are documented, but the intellectual capacity of 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.
Output. The result of inputs and processes applied to those inputs that provide goods or services to customers, investment income (such as dividends or interest), or other revenues.

55-6 The nature of the elements of a business varies by industry and by the structure of an entity’s operations (activities), including the entity’s stage of development. Established businesses often have many different types of inputs, processes, and outputs, whereas new businesses often have few inputs and processes and sometimes only a single output (product). Nearly all businesses also have liabilities, but a business need not have liabilities. In addition, some transferred sets of assets and activities that are not a business may have liabilities.

Both a business and an asset or a group of assets possess one or more inputs. As indicated in ASC 805-10-55-4, what distinguishes a business from an asset or a group of assets is that “[a] business consists of inputs and processes applied to those inputs that have the ability to contribute to the creation of outputs.”

According to ASC 805-10-55-4(b), a process is “[a]ny system, standard, protocol, convention, or rule that when applied to an input or inputs, creates or has the ability to contribute to the creation of outputs.” Examples of processes include:

Strategic management processes — for setting the overall strategy and direction of operations.
Operational processes — for obtaining contracts or customers, or developing, fulfilling, or producing outputs.
Resource management processes — for obtaining inventory and managing operational employees.

While processes are usually documented, they do not need to be. For example, employees are an input, but they may form an organized workforce whose knowledge and ability may be considered a process, even if that process is not documented.

Determining whether a substantive process is present in a set can be challenging. ASC 805-10-55 provides guidance for making that judgment in response to the practice issues that existed under the previous definition of a business. According to the revised guidance, only processes that are used in the creation of outputs should be considered substantive under the definition of a business. For example, accounting, billing, payroll, and other administrative systems typically are not used to create outputs.

While acquiring a contract that gives access to an organized workforce may represent the acquisition of a substantive process, ASC 805-10-55-5F states that assumed contracts that provide for a continuation of revenues — such as customer contracts, customer lists, and leases (from the lessor’s perspective) — should not be considered acquired processes and should be excluded from the analysis.

To help reduce the likelihood that a transaction is inappropriately accounted for as a business acquisition, the Board emphasized in paragraph BC35 of ASU 2017-01 that a process must be important to the ability to create outputs. While ASC 805-10-55-5 notes that a “business need not include all the inputs or processes that the seller used in operating that business . . . to be considered a business, the set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output.”

As indicated in ASC 805-10-55-4(c), outputs are “[t]he result of inputs and processes applied to those inputs that provide goods or services to customers, investment income (such as dividends or interest), or other revenues.” ASU 2017-01 narrowed the definition of outputs to align it with the ability to generate goods or services for customers and make it consistent with the description of outputs in ASC 606. However, as discussed in paragraph BC59 of the ASU, “the Board noted that not all entities have revenues within the scope of Topic 606 and therefore, decided to incorporate other types of revenues in the definition. For example, the Board decided to include the reference to investment income in the definition of outputs in the amendments . . . to ensure that the purchase of an investment company can still qualify as a business combination.”

Although outputs are not required for a set to be a business, ASC 805-10-55 provides different criteria for determining whether a set has one or more substantive processes, depending on whether the set has outputs (i.e., a continuation of revenues before and after the acquisition). Because outputs are usually a fundamental element of a business, the Board reasoned that if there are no outputs, the other elements should be more significant. Therefore, the guidance includes more stringent criteria on what is required for a set to have a substantive process when outputs are not present.

ASC 805-10-55 does not specify the amount of outputs an entity should consider when assessing whether to apply the criteria for a set without outputs rather than a set with outputs. We believe that when determining which criteria to apply, an entity may need to use judgment. For example, if an acquired set has only an insignificant amount of outputs (i.e., revenues), it may be appropriate for an entity to evaluate the criteria for a set without outputs to determine whether a substantive process exists. In addition, because the determination of whether a set is capable of being conducted and managed as a business is performed from a market participant perspective, we believe that an acquired set could still be considered as having outputs even if all its goods or services, or both, were previously being used internally through an intercompany revenue or transfer arrangement, provided that such goods or services, or both, will be recognized as third-party revenue (e.g., a carve-out transaction) after the transaction.

2.4.3.2 Sets Without Outputs

ASC 805-10

55-5D When a set does not have outputs (for example, an early stage company that has not generated revenues), the set will have both an input and a substantive process that together significantly contribute to the ability to create outputs only if it includes employees that form an organized workforce and an input that the workforce could develop or convert into output. The organized workforce must have 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 process (or group of processes) is not critical if, for example, it is considered ancillary or minor in the context of all the processes required to create outputs.
Inputs that employees who form an organized workforce could develop (or are developing) or convert into outputs could include the following:
1. Intellectual property that could be used to develop a good or service
2. Resources that could be developed to create outputs
3. Access to necessary materials or rights that enable the creation of future outputs.
Examples of inputs that could be developed include technology, mineral interests, real estate, and in-process research and development.

ASC 805-10-55-5D states that if a set does not have outputs, a substantive process can only be provided by employees that form an organized workforce with “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.” ASC 805-10-55 does not provide guidance on determining whether employees are providing a “critical” process, except to say that “[a] process (or group of processes) is not critical if, for example, it is considered ancillary or minor in the context of all the processes required to create outputs.” Accordingly, entities will need to use judgment in determining whether a process is critical.

While an organized workforce is an input, it is the workforce’s ability to make the set active that must be evaluated as a substantive process. In paragraph BC41 of ASU 2017-01, the Board explained:

If there is no organized workforce to perform an acquired process, the set on its own likely would not be able to actively contribute to the creation of outputs because the acquirer has to provide all of the activities to perform the process. For example, . . . without an organized workforce, an entity could conclude that the acquisition of a blueprint for an airplane includes a substantive process. When the set does not have outputs, . . . the process embedded in that blueprint is not substantive unless there is an organized workforce that could make the set active and contribute to the production of the airplane.

The determination of whether an organized workforce is performing a critical process requires judgment and varies from transaction to transaction and from industry to industry. Entities should evaluate whether the process (or group of processes) is critical in the context of all the processes required to create outputs. If the process (or group of processes) is considered ancillary or minor in that context, it is not critical. The following factors may be indicators that the acquired organized workforce has the necessary skills, knowledge, or experience to perform a critical process (none of the factors below are individually determinative):

Composition and size of the workforce — Generally, the greater the number of employees in an organized workforce, the more likely the process (or group of processes) they perform is critical. However, the composition of the workforce also needs to be considered. That is, a large number of employees that perform ancillary or minor tasks may not have the requisite skills, knowledge, or experience to perform a critical process. By contrast, a small number of employees that have significant skills, knowledge, or experience may perform a process critical to the development of outputs.
Ability for the set to operate independently — A set that includes an organized workforce that was operating independently before the acquisition may be an indicator that the organized workforce is performing a critical process (or group of processes).
Significant amount of goodwill — A set that includes a significant amount of goodwill may be an indicator that the organized workforce has the necessary skills, knowledge, or experience to perform a critical process (or group of processes).
Advanced stage of activities — A set that includes an organized workforce that is in advanced stages of converting acquired inputs into outputs (i.e., generating revenues) may be an indicator that the processes being performed by the employees are critical. For example, if an acquired set is close to generating revenues on a stand-alone basis and the acquirer does not anticipate the need to add a significant number of employees with requisite skills, knowledge, or experience, this may indicate that the organized workforce is performing a critical process (or group of processes).

When an entity obtains access to an organized workforce as a result of an acquired contractual arrangement, the entity cannot consider such workforce to be an acquired substantive process if outputs are not present. The Board indicated in paragraph BC47 of ASU 2017-01 that:

[W]ithout an employee to manage the performance of the vendor, there are inherent limitations on the processes that can be performed in a development capacity without further decision making or actions from an employee. In contrast, when a vendor is actively contributing to and continuously creating outputs (for example, an asset manager that continuously manages an investment portfolio and generates investment revenues), the Board concluded that the process performed by the service provider is more likely to be substantive and should still be a factor to consider when the set has outputs.

However, the management of service providers could be considered a critical process performed by employees. In paragraph BC48 of ASU 2017-01, the Board noted that “as an example, an entity should come to consistent conclusions when evaluating a set that has 100 employees and a set that has 20 employees with the equivalent of 80 employees replaced by outsourced service providers because the 20 employees would be responsible for the management and performance of the outsourced employees.” If a set without outputs includes both employees and an outsourced workforce, entities must use judgment to determine whether the employees represent an organized workforce that provides a substantive process.

Under ASC 805-10-55-5D(b), for a set without outputs to be a business, it must contain both an organized workforce performing a substantive process and “[i]nputs that employees who form an organized workforce could develop (or are developing) or convert into outputs.” The acquisition of an organized workforce alone is not sufficient to conclude that a set is a business.

The table below summarizes the examples in ASC 805-10-55-65 through 55-81 (see Section 2.4.4), which illustrate scenarios in which an entity analyzes whether a set without outputs is a business.

Case	Facts	Does the Set Without Outputs Have an Input and a Substantive Process?
Case B: Acquisition of a Drug Candidate (Scenario 2 in ASC 805-10-55-65 through 55-69)	Acquisition of a legal entity that contains the rights to two phase 3 compounds; each is being developed to treat a different medical condition. The set is not yet producing outputs. No employees, other assets, or other activities are transferred.	No. The set includes inputs but not a substantive process, since no employees are acquired as part of the transaction. An organized workforce must be present for a set without outputs to have a substantive process.
Case C: Acquisition of Biotech (ASC 805-10-55-70 through 55-72)	Acquisition of a biotech with several IPR&D projects that are in different phases of the FDA approval process and that would treat significantly different diseases. The set includes senior management and scientists who have the necessary skills, knowledge, or experience to perform R&D activities. It is not yet generating revenues.	Yes. The set includes inputs and a substantive process, since senior management and the scientists form an organized workforce that is critical to the ability to develop the inputs into a product that will be provided to customers.
Case D: Acquisition of a Television Station (ASC 805-10-55-73 through 55-76)	Acquisition of an FCC license, broadcasting equipment, and an office building. No employees will be transferred and the set is not producing outputs.	No. The set includes inputs but not a substantive process, since the set does not include an organized workforce. An organized workforce must be present for a set without outputs to have a substantive process.
Case E: Acquisition of a Manufacturing Facility (ASC 805-10-55-77 through 55-81)	Acquisition of an idled manufacturing facility and related equipment but no intellectual property, inventory, customer relationships, or other inputs. To comply with local labor laws, the set must include the furloughed employees.	No. The set includes an organized workforce with the skills to use the equipment but not the necessary intellectual property or other inputs that could be converted into outputs by using the equipment.

2.4.3.3 Sets With Outputs

ASC 805-10

55-5E When the set has outputs (that is, there is a continuation of revenue before and after the transaction), the set will have both an input and a substantive process that together significantly contribute to the ability to create outputs when any of the following are present:

Employees that form an organized workforce that has the necessary skills, knowledge, or experience to perform an acquired process (or group of processes) that when applied to an acquired input or inputs is critical to the ability to continue producing outputs. A process (or group of processes) is not critical if, for example, it is considered ancillary or minor in the context of all of the processes required to continue producing outputs.
An acquired contract that provides access to an organized workforce that has the necessary skills, knowledge, or experience to perform an acquired process (or group of processes) that when applied to an acquired input or inputs is critical to the ability to continue producing outputs. An entity should assess the substance of an acquired contract and whether it has effectively acquired an organized workforce that performs a substantive process (for example, considering the duration and the renewal terms of the contract).
The acquired process (or group of processes) when applied to an acquired input or inputs significantly contributes to the ability to continue producing outputs and cannot be replaced without significant cost, effort, or delay in the ability to continue producing outputs.
The acquired process (or group of processes) when applied to an acquired input or inputs significantly contributes to the ability to continue producing outputs and is considered unique or scarce.

55-5F If a set has outputs, continuation of revenues does not on its own indicate that both an input and a substantive process have been acquired. Accordingly, assumed contractual arrangements that provide for the continuation of revenues (for example, customer contracts, customer lists, and leases [when the set is the lessor]) should be excluded from the analysis in paragraph 805-10-55-5E of whether a process has been acquired.

Like a set without outputs, a set with outputs is a business if it includes, at a minimum, both an input and a substantive process that together significantly contribute to the ability to create outputs. A set has outputs if there is a continuation of revenue before and after the transaction. While the continuation of revenues alone does not mean that a set is a business, the Board concluded in paragraph BC51 of ASU 2017-01 that a set with outputs is more likely to include an input and substantive process than a set without outputs. Therefore, the criteria for determining whether a substantive process is present are less stringent than those for a set that is not producing outputs. According to ASC 805-10-55-5E, when a set has outputs, a substantive process may be provided by any of the following:

“[E]mployees that form an organized workforce.”
“[A]n acquired contract that provides access to an organized workforce.”
A process (or group of processes) that, “when applied to an acquired input or inputs significantly contributes to the ability to continue producing outputs and cannot be replaced without significant cost, effort, or delay in the ability to continue producing outputs.”
A process (or group of processes) that, “when applied to an acquired input or inputs significantly contributes to the ability to continue producing outputs and is considered unique or scarce.”

As indicated by the guidance in ASC 805-10-55-5D, an “organized workforce must have 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.”

The determination of whether an organized workforce is performing a critical process requires judgment and varies from transaction to transaction and from industry to industry. Entities should evaluate whether the process (or group of processes) is critical in the context of all the processes required to create outputs. If that process (or group of processes) is considered ancillary or minor in that context, it is not critical. We generally believe that entities should consider the same factors described in Section 2.4.3.2 to determine whether an organized workforce in a set with outputs has the necessary skills, knowledge, or experience to perform a critical process (or group of processes).

Many industries outsource operating activities that may not be significantly different from those that would be performed by employees (e.g., contract manufacturers or property managers). When a set has outputs, an entity must evaluate acquired contracts to determine whether they represent an acquired substantive process or, possibly, an input. Paragraph BC46 of ASU 2017-01 states:

The Board concluded that the assessment of a contractual arrangement, such as a supply agreement, should be relatively straightforward, meaning those contracts would likely be inputs because the supplier is not applying a process to another input in the set. However, the Board rejected the view that a service provided through a contractual arrangement should never indicate that a substantive process was acquired. The Board observed that there are many industries in which operating activities are outsourced, and the activities performed by a service provider may not be significantly different than the activities that would be performed by employees. The Board acknowledges that in some circumstances, whether an organized workforce accessed through a contractual arrangement performs or provides a process could be subjective and the critical factor to determining whether a set is a business.

Therefore, when a set has outputs, entities must use judgment in determining whether an acquired contract that provides access to an organized workforce also represents a substantive process. Entities should consider the substance of the contract, including:

The nature of the activities performed by the outsourced workforce.
The duration and the renewal terms of the contract.
Whether the outsourced workforce is critical to the ability to continue producing outputs.
Whether the outsourced workforce could be replaced without significant cost, effort, or delay in the ability to continue producing outputs.

Because the guidance in ASC 805-10-55-5E(b) specifically mentions an acquired contract, new contracts originating between the buyer and a third party on the acquisition date would not be considered part of the acquired set in the assessment of the definition of a business. Conversely, as part of an acquisition, the buyer and seller may agree that the seller will continue to provide services to the buyer after the acquisition by using the seller’s existing workforce. Such an arrangement, commonly referred to as a transition services agreement or a TSA, specifies the period of services and the fee to be paid by the buyer. While some believe that a TSA could be considered an acquired contract because of the continuation of services, we believe that a TSA typically does not give the acquirer access to an organized workforce that represents a substantive process because the services provided under a TSA are often limited in both duration and scope.

A substantive process may also be present without an organized workforce when a set has outputs. For example, a set may have one or more automated processes through acquired technology or infrastructure (e.g., automated technology, or a manufacturing or production line). In accordance with ASC 805-10-55-5E, for an automated process to be considered substantive, (1) it must significantly contribute “to the ability to continue producing outputs” when applied to an input or inputs and (2) the acquirer cannot have the ability to replace it “without significant cost, effort, or delay in the ability to continue producing outputs,” or it must be “unique or scarce.”

The table below summarizes the examples in ASC 805-10-55-52 through 55-96 (see Section 2.4.4), which illustrate scenarios in which an entity analyzes whether a set with outputs is a business.

Case	Facts	Does the Set With Outputs Have an Input and a Substantive Process?
Case A: Acquisition of Real Estate (Scenario 2 in ASC 805-10-55-52 through 55-64) (Scenario 3 in ASC 805-10-55-52 through 55-64)	Acquisition of a portfolio of single-family homes, an office park with multiple office buildings, and vendor contracts for outsourced cleaning security and maintenance. The set has continuing revenues through in-place leases.	No. The set has inputs but does not have a substantive process because (1) no employees are acquired, (2) the processes provided by the outsourced contracts are ancillary or minor in the context of all of the processes required in the creation of outputs, and (3) the contracts can be replaced with little cost, effort, or delay and are not unique or scarce.
	Acquisition of a portfolio of single-family homes; an office park with multiple office buildings; employees responsible for leasing, tenant management, and managing operational processes; and vendor contracts for outsourced cleaning security and maintenance. The set has continuing revenues through in-place leases.	Yes. The set has inputs and a substantive process in the form of an organized workforce that performs processes that are critical to the ability to continue producing outputs.
Case F: License of Distribution Rights (ASC 805-10-55-82 through 55-84)	Acquisition of distribution rights, customer contracts, and an at-market supply agreement. The set has outputs through a continuation of revenues.	No. The set has inputs (distribution contracts, customer contracts, and supply agreement) but does not include an organized workforce or other process.
Case G: Acquisition of Brands (ASC 805-10-55-85 through 55-87)	Acquisition of a right to a brand, including all related intellectual property, customer contracts and relationships, inventory, marketing materials, customer incentive programs, supply contracts, specialized equipment, and documented processes. It does not include employees, any of the manufacturing equipment or processes needed to create the product, or distribution facilities or processes. The set has outputs through a continuation of revenues.	Yes. Even though no employees are acquired, the set includes inputs and a substantive process in the form of unique manufacturing processes.
Case H: Acquisition of Loan Portfolio (Scenario 2 in ASC 805-10-55-88 through 55-96) (Scenario 3 in ASC 805-10-55-88 through 55-96)	Acquisition of a portfolio of commercial loans. No employees are acquired, and the set has a continuation of revenues (interest income).	No. The set has inputs but does not have a substantive process because it does not include an organized workforce or other processes.
	Acquisition of a portfolio of commercial loans and the employees that managed the credit risk of the portfolio and the relationship with the borrowers. The set has a continuation of revenues (interest income).	Yes. The set includes an input and a substantive process in the form of an organized workforce that performs processes that are critical to the ability to continue to produce outputs.

2.4.3.4 Groups of Processes

Individual processes that are used to create outputs may sometimes be considered insignificant on their own but could be substantive as a group because all the processes together could be difficult to replace without significant cost or effort or a delay in operations. In determining whether a substantive process is present, entities should consider whether a group of processes are together significant.

2.4.3.5 Presence of Goodwill

ASC 805-10

55-9 When evaluating whether a set meets the criteria in paragraphs 805-10-55-5D through 55-5E, the presence of more than an insignificant amount of goodwill may be an indicator that the acquired process is substantive and, therefore, the acquired set is a business. However, a business need not have goodwill.

To help entities evaluate whether a set includes a substantive process, the FASB notes in ASC 805-10-55-9 that “the presence of more than an insignificant amount of goodwill may be an indicator that the acquired process is substantive.” That is, the presence of more than an insignificant amount of goodwill could be an indicator that an organized workforce is performing a critical process or that an acquired process in a set is substantive.

Paragraph B313 of the Basis for Conclusions of FASB Statement 141(R) describes components that are conceptually part of goodwill — the fair values of “the going-concern element of the acquiree’s existing business” and “the expected synergies and other benefits from combining the acquirer’s and acquiree’s net assets and businesses.” The guidance also lists elements that are captured in the measurement of goodwill in a business combination but are not conceptually part of goodwill — namely, “[o]vervaluation of the consideration paid by the acquirer stemming from [valuation] errors” and “[o]verpayment or underpayment by the acquirer.” We believe that while the nonrecognition of certain assets and liabilities and the measurement of certain assets or liabilities at amounts other than fair value are not conceptually part of goodwill, those components are captured in the measurement of goodwill. In evaluating goodwill as an indicator of a substantive process, entities should consider the reasons why they have calculated an excess and whether the excess is related to the elements that are conceptually part of goodwill.

Often, part of an excess is the result of an assembled workforce intangible asset that is subsumed into goodwill in a business combination. In such cases, entities should consider whether the employees represent an organized workforce as described in Section 2.4.3.2. That is, in accordance with ASC 805-10-55-5D, entities should assess whether the employees “have 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.” The presence of an assembled workforce that has significant fair value may be an indicator that the employees are performing a substantive process. Similarly, an excess may indicate that there is value in an acquired process that would not be captured in an identifiable asset.

2.4.4 Examples Illustrating the Application of the Guidance

The examples in ASC 805-10-55-52 through 55-96 below illustrate the application of the guidance on the definition of a business discussed throughout this chapter.

ASC 805-10

Case A: Acquisition of Real Estate

Scenario 1

55-52 ABC acquires, renovates, leases, sells, and manages real estate properties. ABC acquires a portfolio of 10 single-family homes that each have in-place leases. The only elements included in the acquired set are the 10 single-family homes and the 10 in-place leases. Each single-family home includes the land, building, and property improvements. Each home has a different floor plan, square footage, lot, and interior design. No employees or other assets are acquired.

55-53 ABC first considers the threshold guidance in paragraphs 805-10-55-5A through 55-5C. ABC concludes that the land, building, property improvements, and in-place leases at each property can be considered a single asset in accordance with paragraph 805-10-55-5B. That is, the building and property improvements are attached to the land and cannot be removed without incurring significant cost. Additionally, the in-place lease is an intangible asset that should be combined with the related real estate and considered a single asset.

55-54 ABC also concludes that the 10 single assets (the combined land, building, in-place lease intangible, and property improvements) are similar. Each home has a different floor plan; however, the nature of the assets (all single-family homes) are similar. ABC also concludes that the risks associated with managing and creating outputs are not significantly different. That is, the risks associated with operating the properties and tenant acquisition and management are not significantly different because the types of homes and class of customers are not significantly different. Similarly, the risks associated with operating in the real estate market of the homes acquired are not significantly different. Consequently, ABC concludes that substantially all of the fair value of the gross assets acquired is concentrated in the group of similar identifiable assets; thus, the set is not a business.

Scenario 2

55-55 Assume the same facts as in Scenario 1 except that ABC also acquires an office park with six 10-story office buildings leased to maximum occupancy of which all have significant fair value. ABC also acquires the vendor contracts for outsourced cleaning, security, and maintenance. Seller’s employees that perform leasing (sales, underwriting, and so forth), tenant management, financing, and other strategic management processes are not included in the set. ABC plans to replace the property management and employees with its own internal resources.

55-56 ABC concludes that the single-family homes and office park are not similar assets. ABC considers the risks associated with operating the assets, obtaining tenants, and tenant management between the single-family homes and office park to be significantly different because the scale of operations and risks associated with the class of customers are significantly different. Therefore, substantially all of the fair value of the gross assets acquired is not concentrated in a single identifiable asset or group of similar identifiable assets. Thus, ABC must further evaluate whether the set has the minimum requirements to be considered a business.

55-57 The set has continuing revenues through the in-place leases and, therefore, has outputs. ABC must consider the criteria in paragraph 805-10-55-5E to determine whether the set includes both an input and a substantive process that together significantly contribute to the ability to create outputs.

55-58 ABC concludes that the criteria in paragraph 805-10-55-5E(a) through (b) are not met because the set does not include employees and the processes performed through the cleaning and security contracts (the only processes acquired) will be considered ancillary or minor in the context of all the processes required to create outputs in the real estate industry. That is, while those outsourcing agreements may be considered to provide an organized workforce that performs cleaning and security processes when applied to the building, the processes performed by the cleaning, security, and maintenance personnel are not considered critical in the context of all the processes required to create outputs.

55-59 ABC also concludes that the criterion in paragraph 805-10-55-5E(c) is not met because the cleaning and security processes could be easily replaced with little cost, effort, or delay in the ability to continue producing outputs. While the cleaning and security processes are necessary for continued operations of the buildings, these contracts can be replaced quickly with little effect on the ability to continue producing outputs.

55-60 ABC concludes that the criterion in paragraph 805-10-55-5E(d) is not met because the cleaning and security contracts are not considered unique or scarce. That is, these types of arrangements are readily accessible in the marketplace.

55-61 Because none of the criteria were met, ABC concludes that the set does not include both an input and substantive processes that together significantly contribute to the ability to create outputs and, therefore, is not considered a business.

Scenario 3

55-62 Assume the same facts as in Scenario 2, except that the set includes the employees responsible for leasing, tenant management, and managing and supervising all operational processes.

55-63 The set has continuing revenues through the in-place leases and, therefore, has outputs. ABC must consider the criteria in paragraph 805-10-55-5E to determine whether the set includes both an input and a substantive process that together significantly contribute to the ability to create outputs.

55-64 ABC determines that the criterion in paragraph 805-10-55-5E(a) is met because the set includes an organized workforce that performs processes that when applied to the acquired inputs in the set (the land, building, and in-place leases) are critical to the ability to continue producing outputs. That is, ABC concludes that the leasing, tenant management, and supervision of the operational processes are critical to the creation of outputs. Because it includes both an input and a substantive process, the set is considered a business.

Case B: Acquisition of a Drug Candidate

Scenario 1

55-65 Pharma Co. purchases from Biotech a legal entity that contains the rights to a Phase 3 (in the clinical research phase) compound being developed to treat diabetes (the in-process research and development project). Included in the in-process research and development project is the historical know-how, formula protocols, designs, and procedures expected to be needed to complete the related phase of testing. The legal entity also holds an at-market clinical research organization contract and an at-market clinical manufacturing organization contract. No employees, other assets, or other activities are transferred.

55-66 Pharma Co. first considers the guidance in paragraphs 805-10-55-5A through 55-5C. Pharma Co. concludes that the in-process research and development project is an identifiable intangible asset that would be accounted for as a single asset in a business combination. Pharma Co. also qualitatively concludes that there is no fair value associated with the clinical research organization contract and the clinical manufacturing organization contract because the services are being provided at market rates and could be provided by multiple vendors in the marketplace. Therefore, all of the consideration in the transaction will be allocated to the in-process research and development project. As such, Pharma Co. concludes that substantially all of the fair value of the gross assets acquired is concentrated in the single in-process research and development asset and the set is not a business.

Scenario 2

55-67 Pharma Co. purchases from Biotech a legal entity that contains the rights to a Phase 3 compound being developed to treat diabetes (Project 1) and a Phase 3 compound being developed to treat Alzheimer’s disease (Project 2). Included with each project are the historical know-how, formula protocols, designs, and procedures expected to be needed to complete the related phase of testing. The legal entity also holds at-market clinical research organization contracts and at-market clinical manufacturing organization contracts associated with each project. Assume that Project 1 and Project 2 have equal fair value. No employees, other assets, or other activities are transferred.

55-68 Pharma Co. concludes that Project 1 and Project 2 are each separately identifiable intangible assets, both of which would be accounted for as a single asset in a business combination. Pharma Co. then considers whether Project 1 and Project 2 are similar assets. Pharma Co. notes that the nature of the assets is similar in that both Project 1 and Project 2 are in-process research and development assets in the same major asset class. However, Pharma Co. concludes that Project 1 and Project 2 have significantly different risks associated with creating outputs from each asset because each project has different risks associated with developing and marketing the compound to customers. The projects are intended to treat significantly different medical conditions, and each project has a significantly different potential customer base and expected market and regulatory risks associated with the assets. Thus, Pharma Co. concludes that substantially all of the fair value of the gross assets acquired is not concentrated in a single identifiable asset or group of similar identifiable assets and that it must further evaluate whether the set has the minimum requirements to be considered a business.

55-69 Because the set does not have outputs, Pharma Co. evaluates the criteria in paragraph 805-10-55-5D to determine whether the set has both an input and a substantive process that together significantly contribute to the ability to create outputs. Pharma Co. concludes that the criteria are not met because the set does not have employees. As such, Pharma Co. concludes that the set is not a business.

Case C: Acquisition of Biotech

55-70 Pharma Co. buys all of the outstanding shares of Biotech. Biotech’s operations include research and development activities on several drug compounds that it is developing (in-process research and development projects). The in-process research and development projects are in different phases of the U.S. Food and Drug Administration approval process and would treat significantly different diseases. The set includes senior management and scientists that have the necessary skills, knowledge, or experience to perform research and development activities. In addition, Biotech has long-lived tangible assets such as a corporate headquarters, a research lab, and lab equipment. Biotech does not yet have a marketable product and, therefore, has not generated revenues. Assume that each research and development project has a significant amount of fair value.

55-71 Pharma Co. first considers the guidance in paragraphs 805-10-55-5A through 55-5C. The identifiable assets in the set include multiple in-process research and development projects and tangible assets (the corporate headquarters, the research lab, and the lab equipment). Pharma Co. concludes that the in-process research and development projects are not similar assets because the projects have significantly different risks associated with managing the assets and creating the outputs (that is, because there are significantly different development risks in the different phases of development, market risks related to the different customer base, and potential markets for the compounds). In addition, Pharma Co. concludes that there is fair value associated with the acquired workforce because of the proprietary knowledge of and experience with Biotech’s ongoing development projects and the potential for creation of new development projects that the workforce embodies. As such, Pharma Co. concludes that substantially all of the fair value of the gross assets acquired is not concentrated in a single identifiable asset or group of similar identifiable assets and that it must further evaluate whether the set has the minimum requirements to be considered a business.

55-72 Because the set does not have outputs, Pharma Co. evaluates the criteria in paragraph 805-10-55-5D to determine whether the set has both an input and a substantive process that together significantly contribute to the ability to create outputs. Pharma Co. concludes that the criteria are met because the scientists make up an organized workforce that has the necessary skills, knowledge, or experience to perform processes that when applied to the in-process research and development inputs is critical to the ability to develop those inputs into a product that can be provided to a customer. Pharma Co. also determines that there is a more-than-insignificant amount of goodwill (including the fair value associated with the workforce), which is another indicator that the workforce is performing a critical process. Thus, the set includes both inputs and substantive processes and is a business.

Case D: Acquisition of a Television Station

55-73 Company A is a television broadcaster whose principal business is the ownership and operation of a television station group in the United States through which it broadcasts its proprietary health-care-related programming. Company B owns and operates several television stations in the western United States. Because of a recent merger, Company B must divest itself of a station in Portland, Oregon (KPOR), and agrees to sell the station to Company A.

55-74 Company A plans to change KPOR’s programming format to its proprietary health-care-related programming. Therefore, Company A will receive only the U.S. Federal Communications Commission license, the broadcasting equipment, and the office building. KPOR will be integrated into Company A’s operations, with most of the station processes centralized at Company A’s corporate headquarters. Company A will not extend offers of employment to any of KPOR’s employees or assume any of KPOR’s contractual relationships.

55-75 Company A first considers the guidance in paragraphs 805-10-55-5A through 55-5C. The U.S. Federal Communications Commission license is an intangible asset that is recognized and measured separately in a business combination, while the broadcast equipment and building are tangible nonfinancial assets in different major classes. Company A concludes that the broadcast equipment and building are not considered a single asset because the equipment is not attached to the building and can be removed without significant cost or diminution in fair value. Furthermore, none of the assets will be considered similar in accordance with paragraph 805-10-55-5C because the U.S. Federal Communications Commission license cannot be considered similar to tangible assets and the tangible assets are in different major asset classes. Each of the separate identifiable assets has significant fair value. Thus, Company A concludes that substantially all of the fair value of the gross assets acquired is not concentrated in a single identifiable asset or group of similar identifiable assets and that it must further evaluate whether the set has the minimum requirements to be considered a business.

55-76 The set does not have outputs; therefore, Company A considers the criteria in paragraph 805-10-55-5D to determine whether the set includes both an input and a substantive process that together significantly contribute to the ability to create outputs. The set does not include an organized workforce, so it does not meet the criteria in paragraph 805-10-55-5D. Therefore, the set does not include both an input and a substantive process and is not considered a business.

Case E: Acquisition of a Manufacturing Facility

55-77 Widget Co. manufactures complex equipment and has manufacturing facilities throughout the world. Widget Co. decided to idle a facility in a foreign jurisdiction in a reorganization of its manufacturing footprint and furloughed the assembly line employees.

55-78 Acquirer enters into an agreement to purchase a manufacturing facility and related equipment from Widget Co. To comply with the local labor laws, Acquirer also must assume the furloughed employees.

55-79 The assets acquired include the equipment and facility (land and building) but no intellectual property, inventory, customer relationships, or any other inputs.

55-80 Acquirer first considers the guidance in paragraphs 805-10-55-5A through 55-5C. Acquirer concludes that the equipment in the facility can be removed without significant cost or diminution in utility or fair value because the equipment is not attached to the building and can be used in many types of manufacturing facilities. Therefore, the equipment and building are not a single asset. Furthermore, the equipment and facility are not considered similar assets because they are different major classes of tangible assets. Acquirer determines that there is significant fair value in both the equipment and the facility and, thus, concludes that it must further evaluate whether the set has the minimum requirements to be considered a business.

55-81 The set is not currently producing outputs because there is no continuation of revenue before and after the transaction; therefore, Acquirer considers the criteria in paragraph 805-10-55-5D and whether the set includes both employees that form an organized workforce and an input that the workforce could develop or convert into output. The set includes employees that have the necessary skills, knowledge, or experience to use the equipment; however, without intellectual property or other inputs that could be converted into outputs using the equipment, the set does not include both an organized workforce and an input that will meet the criteria in paragraph 805-10-55-5D. That is, the equipment itself cannot be developed or converted into an output by those employees. Therefore, the set is not a business.

Case F: License of Distribution Rights

55-82 Company A is a distributor of food and beverages. Company A enters into an agreement to sublicense the Latin American distribution rights of Yogurt Brand F to Company B, whereby Company B will distribute Yogurt Brand F in Latin America. As part of the agreement, Company A transfers the existing customer contracts in Latin America to Company B and an at-market supply contract with the producer of Yogurt Brand F. Company A retains all of its employees and distribution capabilities.

55-83 Company B first considers the guidance in paragraphs 805-10-55-5A through 55-5C. The identifiable assets that could be recognized in a business combination include the license to distribute Yogurt Brand F, customer contracts, and the supply agreement. Company B concludes that the license and customer contracts will have fair value assigned to them. Company B concludes that neither asset represents substantially all of the fair value of the gross assets. Company B then considers whether the license and customer contracts are a group of similar intangible assets. Because the license and customer contracts are in different major classes of identifiable intangible assets, they are not considered similar assets. Therefore, substantially all of the fair value of the gross assets acquired is not concentrated in a single identifiable asset or group of similar identifiable assets, and Company B must evaluate whether the set has both an input and a substantive process.

55-84 The set has outputs through the continuation of revenues with customers in Latin America. As such, Company B must evaluate the criteria in paragraph 805-10-55-5E to determine whether the set includes an input and a substantive process that together significantly contribute to the ability to create outputs. Company B considers whether the acquired contracts are providing access to an organized workforce that performs a substantive process. However, because the contracts are not providing a service that applies a process to another acquired input, Company B concludes that the substance of the contracts are only that of acquiring inputs. The set is not a business because:

It does not include an organized workforce that could meet the criteria in paragraph 805-10-55- 5E(a) through (b).
There are no acquired processes that could meet the criteria in paragraph 805-10-55-5E(c) through (d).
It does not include both an input and a substantive process.

Case G: Acquisition of Brands

55-85 Company A is a global producer of food and beverages. Company A sells the worldwide rights of Yogurt Brand F, including all related intellectual property, to Company B. Company B also acquires all customer contracts and relationships, finished goods inventory, marketing materials, customer incentive programs, raw material supply contracts, specialized equipment specific to manufacturing Yogurt Brand F, and documented processes and protocols to produce Yogurt Brand F. Company B does not receive employees, manufacturing facilities, all of the manufacturing equipment and processes required to produce the product, and distribution facilities and processes.

55-86 Company B first considers the guidance in paragraphs 805-10-55-5A through 55-5C. The gross assets include intellectual property (the trademark, the related trade name, and recipes) associated with Yogurt Brand F (the intellectual property associated with the brand is determined to be a single intangible asset in accordance with the guidance in paragraph 805-20-55-18), customer contracts and related relationships, equipment, finished goods inventory, and the excess of the consideration transferred over the fair value of the net assets acquired. Company B concludes that substantially all of the fair value of the gross assets acquired is not concentrated in a single identifiable asset or group of similar identifiable assets even though, for purposes of the analysis, the intellectual property is considered to be a single identifiable asset. In addition, because there is significant fair value in both tangible assets and intangible assets, Company B concludes that there is not a group of similar assets that meets this threshold.

55-87 The set has outputs through the continuation of revenues, and Company B must consider the criteria in paragraph 805-10-55-5E to determine whether the set includes both inputs and a substantive process that together significantly contribute to the ability to create outputs. The set does not include an organized workforce and, therefore, does not meet the criteria in paragraph 805-10-55-5E(a) through (b). However, the acquired manufacturing processes are unique to Yogurt Brand F, and when those processes are applied to acquired inputs such as the intellectual property, raw material supply contracts, and the equipment, they significantly contribute to the ability to continue producing outputs. As such, the criterion in paragraph 805-10-55-5E(c) is met, and the set includes both inputs and substantive processes. Because the set includes inputs and substantive processes that together significantly contribute to the ability to create outputs, it is considered a business.

Case H: Acquisition of Loan Portfolio

Scenario 1

55-88 Bank A purchases a loan portfolio from Bank Z. The portfolio of loans consists of residential mortgages with terms, size, and risk ratings that are not significantly different. Bank A does not take over the employees of Bank Z that managed the credit risk of the portfolio and the relationship with the borrowers (such as brokers, vendors, and risk managers).

55-89 Bank A first considers the guidance in paragraphs 805-10-55-5A through 55-5C. Bank A concludes that the nature of the assets (residential mortgage loans) is similar. Bank A also concludes that the risks associated with managing and creating outputs are not significantly different because the terms, size, and risk ratings of the loans are not significantly different. Because all of the fair value of the gross assets acquired is in a group of similar identifiable assets, the set is not a business.

Scenario 2

55-90 Assume the same facts as in Scenario 1 except that the portfolio of loans consists of commercial loans with term, size, and risk ratings that are significantly different.

55-91 Bank A first considers the guidance in paragraphs 805-10-55-5A through 55-5C. Bank A must consider whether the loans are similar. Bank A concludes that the nature of the assets (commercial loans) is similar; however, because the term, size, and risk ratings of the loans are significantly different, Bank A concludes that the risks associated with managing and creating outputs are significantly different. Thus, Bank A concludes that substantially all of the fair value of the gross assets acquired is not concentrated in a single identifiable asset or group of similar identifiable assets and that it must further evaluate whether the set has the minimum requirements to be considered a business.

55-92 The set has outputs through the continuation of revenues (interest income). Consequently, Bank A considers the criteria in paragraph 805-10-55-5E to determine whether the set includes both inputs and a substantive process that together significantly contribute to the ability to create outputs. Because the set does not include an organized workforce or acquired processes, the criteria in paragraph 805-10-55-5E are not met and the set is not a business.

Scenario 3

55-93 Assume the same facts as in Scenario 2 except that Bank A takes over the employees of Bank Z that managed the credit risk of the portfolio and the relationship with the borrowers (such as brokers and risk managers). Additionally, consideration transferred is significantly higher than Bank A’s estimate of the fair value of the loan portfolio.

55-94 Bank A first considers the guidance in paragraphs 805-10-55-5A through 55-5C. Bank A concludes that the loan portfolio does not consist of similar identifiable assets. Bank A also concludes that there is significant fair value associated with different groups of financial assets and the acquired workforce. As such, Bank A concludes that substantially all of the fair value of the gross assets acquired is not concentrated in a single identifiable asset or group of similar identifiable assets and that it must further evaluate whether the set has met the minimum requirements to be considered a business.

55-95 The set has outputs through the continuation of revenues (interest income). Consequently, Bank A considers the criteria in paragraph 805-10-55-5E to determine whether the set includes both an input and a substantive process that together significantly contribute to the ability to create outputs.

55-96 Bank A evaluates the criteria in paragraph 805-10-55-5E and concludes that the criterion in paragraph 805-10-55-5E(a) is met because the set includes an organized workforce that performs processes (customer relationship management and credit risk management) critical to the ability to continue producing outputs; therefore, the set is a business.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.