Chapter 2 — Identifying a Business Combination
Chapter 2 — Identifying a Business Combination
ASC 805 requires an entity to account for a business combination by
using the acquisition method. For an entity to apply the acquisition method, the
transaction must meet the definition of a business combination and the net assets
acquired must meet the definition of a business in ASC 805. This chapter discusses
those definitions and addresses the scope of the business combinations guidance in
ASC 805-10, ASC 805-20, and ASC 805-30.
2.1 Definition of a Business Combination
ASC 805-10
25-1 An entity shall determine whether a transaction or other event
is a business combination by applying the definition in this Subtopic, which requires that
the assets acquired and liabilities assumed constitute a business. If the assets acquired
are not a business, the reporting entity shall account for the transaction or other event
as an asset acquisition. An entity shall account for each business combination by applying
the acquisition method.
The ASC master glossary defines a business combination as:
A transaction or other event in which an acquirer obtains control of one or more businesses. Transactions
sometimes referred to as true mergers or mergers of equals also are business combinations.
A business combination typically occurs when an acquirer purchases the equity
interests or net assets of one or more businesses in exchange for cash, equity interests of the
acquirer, or other consideration. However, the definition of a business combination is broader
and applies to all transactions or events in which an acquirer obtains control of a business.
ASC 805-10 includes examples of ways in which an acquirer may obtain control of a business:
ASC 805-10
55-2 Paragraph 805-10-25-1 requires an entity to determine whether a transaction or event is a business
combination. In a business combination, an acquirer might obtain control of an acquiree in a variety of ways,
including any of the following:
- By transferring cash, cash equivalents, or other assets (including net assets that constitute a business)
- By incurring liabilities
- By issuing equity interests
- By providing more than one type of consideration
- Without transferring consideration, including by contract alone (see paragraph 805-10-25-11).
55-3 A business combination may be structured in a variety of ways for legal, taxation, or other reasons, which
include but are not limited to, the following:
- One or more businesses become subsidiaries of an acquirer or the net assets of one or more businesses are legally merged into the acquirer.
- One combining entity transfers its net assets or its owners transfer their equity interests to another combining entity or its owners.
- All of the combining entities transfer their net assets or the owners of those entities transfer their equity interests to a newly formed entity (sometimes referred to as a roll-up or put-together transaction).
- A group of former owners of one of the combining entities obtains control of the combined entity.
The ASC master glossary indicates that the term “control” has the same meaning as the term “controlling
financial interest” in ASC 810-10-15-8. Therefore, an entity applies the guidance in ASC 810-10 to
determine whether it has obtained a controlling financial interest in a business. ASC 810-10-15-8 states:
For legal entities other than limited partnerships, the usual condition for a controlling financial interest is
ownership of a majority voting interest, and, therefore, as a general rule ownership by one reporting entity,
directly or indirectly, of more than 50 percent of the outstanding voting shares of another entity is a condition
pointing toward consolidation. The power to control may also exist with a lesser percentage of ownership, for
example, by contract, lease, agreement with other stockholders, or by court decree.
In assessing whether it has obtained control of a business under ASC 810-10, an
entity begins with an assessment of whether the acquiree is a VIE under the VIE model, which was
established for situations in which control may be demonstrated other than by the possession of
a majority of the voting rights in a legal entity. Accordingly, the evaluation of whether an
entity has a controlling financial interest in a VIE focuses on “the power to direct the
activities of a VIE that most significantly impact the VIE’s economic performance” and “the
obligation to absorb losses of the VIE that could potentially be significant to the VIE or the
right to receive benefits from the VIE that could potentially be significant to the VIE.” Under
ASC 810-10-30-2, if the acquired business is determined to be a VIE on the basis of the guidance
in ASC 810-10, “[t]he initial consolidation of a VIE that is a business is a business
combination and shall be accounted for in accordance with the provisions in Topic 805.”
If a VIE does not meet the definition of a business, the primary beneficiary
applies the initial-measurement guidance in ASC 805 to the VIE’s assets and liabilities, except
for goodwill. The primary beneficiary is prohibited from recognizing goodwill that otherwise
might be measured and instead recognizes a loss. ASC 810-10-30-3 and 30-4 state:
ASC 810-10
30-3 When a reporting entity becomes the primary beneficiary of a VIE that is not a business, no goodwill shall
be recognized. The primary beneficiary initially shall measure and recognize the assets (except for goodwill) and
liabilities of the VIE in accordance with Sections 805-20-25 and 805-20-30. However, the primary beneficiary
initially shall measure assets and liabilities that it has transferred to that VIE at, after, or shortly before the date
that the reporting entity became the primary beneficiary at the same amounts at which the assets and liabilities
would have been measured if they had not been transferred. No gain or loss shall be recognized because of
such transfers.
30-4 The primary beneficiary of a VIE that is not a business shall recognize a gain or loss for the difference
between (a) and (b):
- The sum of:
- The fair value of any consideration paid
- The fair value of any noncontrolling interests
- The reported amount of any previously held interests
- The net amount of the VIE’s identifiable assets and liabilities recognized and measured in accordance with Topic 805.
If the acquiree is not a VIE, an entity proceeds to the voting interest model. Under that model, an entity
with ownership of a majority of the voting interests of a legal entity is generally considered to have a
controlling financial interest in the entity. However, ASC 810-10-15-8 notes that “control may also exist
with a lesser percentage of ownership” in certain situations. In limited situations, an entity may obtain
control over another entity that is not a VIE through a contractual arrangement rather than through
voting interests (see Section 6.6.3 for more information).
For more information, see Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial
Interest.
2.2 Transactions Within the Scope of ASC 805-10, ASC 805-20, and ASC 805-30
ASC 805-10
15-2 The guidance in the Business Combinations Topic applies to all entities, with specific qualifications and
exceptions in paragraph 805-10-15-4.
15-3 The guidance in the Business Combinations Topic applies to all transactions or other events that meet the
definition of a business combination or an acquisition by a not-for-profit entity.
The guidance in ASC 805-10, ASC 805-20, and ASC 805-30 applies to all transactions or events in which
an entity obtains control over one or more businesses. ASC 805-10 specifies that the acquisition method
should be used to account for the following types of transactions:
- Roll-up or put-together transactions — see Section 2.2.1.
- Combinations between two or more mutual entities — see Section 2.2.2.
- True mergers or mergers of equals — see Section 2.2.3.
- Acquisitions in which control, but less than 100 percent of the equity interests, is obtained (partial acquisitions) — see Section 6.4.
- Business combinations achieved in stages (step acquisitions) — see Section 6.5.
- Business combinations achieved without the transfer of consideration — see Section 6.6.
2.2.1 Roll-Up or Put-Together Transactions
In some transactions, all the combining entities transfer their net assets or the owners of those entities
transfer their equity interests to a newly formed entity. Often, the entities are in the same or similar lines
of business. Such transactions are sometimes referred to as “roll-up” or “put-together” transactions. In
some cases, one of the owners receives a majority of the voting interests of the combined entity, but
in other cases no one individual owner does. Regardless, ASC 805-10-55-3(c) indicates that roll-up or
put-together transactions should be accounted for by using the acquisition method.
The FASB discussed its view on roll-up or put-together transactions in paragraph
B27 of Statement 141(R), which states:
The Boards concluded
that most business combinations, both two-party transactions and those
involving three or more entities (multiparty combinations) are acquisitions.
The Boards acknowledged that some multiparty combinations (in particular,
those that are commonly referred to as roll-up or put-together transactions)
might not be acquisitions; however, they noted that the acquisition method
has generally been used to account for them. The Boards decided not to
change that practice at this time. Consequently, [ASC 805-10, ASC 805-20,
and ASC 805-30 require] the acquisition method to be used to account for all
business combinations, including those that some might not consider
acquisitions.
As a result, in a roll-up or put-together transaction, one entity is identified
as the acquirer (see Section
3.1) and the net assets of the other entities are recognized by
using the acquisition method.
2.2.2 Combinations Between Two or More Mutual Entities
Business combinations between two or more mutual entities are within the scope of ASC 805. The ASC
master glossary defines a mutual entity as:
An entity other than an investor-owned entity that provides dividends, lower costs, or other economic benefits
directly and proportionately to its owners, members, or participants. Mutual insurance entities, credit unions,
and farm and rural electric cooperatives are examples of mutual entities.
Because a combination of mutual entities involves an exchange, albeit typically
of membership interests, ASC 805 makes no concession regarding application of
the acquisition method of accounting. Consequently, in a combination between
mutual entities, one of the entities must be identified as the acquirer (see
Section 3.1)
and the acquirer must apply the acquisition method to the acquired assets and
assumed liabilities. ASC 805 provides guidance on measuring the consideration
transferred in a combination between mutual entities, as addressed in Section 5.10.1.
2.2.3 True Mergers or Mergers of Equals
The term “merger of equals” is sometimes used to describe a transaction in which two entities of
approximately equal size combine to form a new company. The definition of a business combination in
the ASC master glossary specifies that “[t]ransactions sometimes referred to as true mergers or mergers
of equals also are business combinations.” The FASB’s rationale for including mergers of equals within
the scope of ASC 805-10, ASC 805-20, and ASC 805-30 was that mergers of equals between for-profit
businesses or mutual entities may not be frequent enough in practice to warrant developing a separate
accounting model for them. As a result, in a merger between two businesses, one of the entities must
be identified as the acquirer, and the acquirer must apply the acquisition method to the acquired assets
and assumed liabilities even when, for example, the parties characterize the transaction as a merger of
equals, the entities are of approximately equal size, or the initial composition of the governing body and
of management are equal or close to equal. However, determining whether a transaction is a merger
of equals or a joint venture can be challenging. As discussed below, joint control is not the only defining
characteristic of a joint venture. A joint venture is also expected to meet the definition of a “corporate
joint venture” in the ASC master glossary. See Section 2.3.1 for information about identifying a joint
venture arrangement.
2.2.4 Multiple Arrangements With a Seller That Result in a Business Combination
An acquirer and a seller may agree to transfer a business in more than one
transaction for regulatory or other purposes. Sometimes, the parties execute the
acquisition as part of a single agreement; other times, the parties enter into
multiple separate agreements. In certain cases, each individual acquisition may
not meet the definition of a business but would meet it if all the acquisitions
were evaluated together. For example, the acquirer and seller may agree to
transfer what would constitute a business in the first transaction and agree to
transfer only inputs (e.g., customer contracts) in a second transaction. In
other cases, the parties may enter into a contract to transfer multiple
individual businesses under which each of the individual acquisitions close at
different times and in various reporting periods. In such cases, the acquisition
agreement may include a single acquisition price for all the acquisitions.
Alternatively, each business may be priced separately and, while each individual
amount may not represent the fair value of the related business, the total
acquisition price will represent the fair value of all the businesses together.
In some instances, it may be appropriate to evaluate the separate transactions as
a single acquisition. We believe that when performing this evaluation, an entity
should consider the following factors listed in ASC 810-10-40-6 related to
identifying when multiple deconsolidation arrangements should be accounted for
as a single transaction:
- “They are entered into at the same time or in contemplation of one another.”
- “They form a single transaction designed to achieve an overall commercial effect.”
- “The occurrence of one arrangement is dependent on the occurrence of at least one other arrangement.”
- “One arrangement considered on its own is not economically justified, but they are economically justified when considered together. An example is when one disposal is priced below market, compensated for by a subsequent disposal priced above market.”
All facts and circumstances associated with such arrangements should be
considered in the evaluation. When the facts and circumstances indicate that
multiple arrangements should be accounted for as a single transaction
representing a business combination, an entity may need to use judgment in
applying acquisition accounting to each arrangement if closing dates are in
different reporting periods. For example, when goodwill is expected to be
recognized if all the transactions are accounted for together, a bargain
purchase gain should not be recognized, even provisionally, when no bargain
purchase gain is expected to result in total.
See Section 6.5 for information about
business combinations that are achieved in stages when an acquirer obtains
control of an acquiree in which it held a noncontrolling equity interest
immediately before the acquisition date.
2.3 Transactions Outside the Scope of ASC 805-10, ASC 805-20, and ASC 805-30
The guidance in ASC 805-10, ASC 805-20, and ASC 805-30 applies to all transactions or events in which
an entity obtains control over one or more businesses. However, ASC 805-10-15-4 includes a list of
scope exceptions, which are described in further detail below.
ASC 805-10
15-4 The guidance in the Business Combinations Topic does not apply to any of the following:
- The formation of a joint venture
- The acquisition of an asset or a group of assets that does not constitute a business or a nonprofit activity
- A combination between entities, businesses, or nonprofit activities under common control (see paragraph 805-50-15-6 for examples)
- An acquisition by a not-for-profit entity for which the acquisition date is before December 15, 2009 or a merger of not-for-profit entities (NFPs)
- A transaction or other event in which an NFP obtains control of a not-for-profit entity but does not consolidate that entity, as described in paragraph 958-810-25-4. The Business Combinations Topic also does not apply if an NFP that obtained control in a transaction or other event in which consolidation was permitted but not required decides in a subsequent annual reporting period to begin consolidating a controlled entity that it initially chose not to consolidate.
- Financial assets and financial liabilities of a consolidated variable interest entity that is a collateralized financing entity within the scope of the guidance on collateralized financing entities in Subtopic 810-10.
2.3.1 Joint Venture Formations
The formation of a joint venture is outside the scope of ASC 805-10, ASC 805-20, and ASC 805-30. Paragraph B61 of FASB Statement 141(R) states:
In developing Statement 141, the FASB noted that
constituents consider the guidance in paragraph 3(d) of APB Opinion No. 18,
The Equity Method of Accounting for Investments in Common Stock,
in assessing whether an entity is a joint venture, and it decided not to
change that practice in its project on business combinations.
The ASC master glossary defines a corporate joint venture as:
A corporation owned and operated by a small group of
entities (the joint venturers) as a separate and specific business or
project for the mutual benefit of the members of the group. A government may
also be a member of the group. The purpose of a corporate joint venture
frequently is to share risks and rewards in developing a new market, product
or technology; to combine complementary technological knowledge; or to pool
resources in developing production or other facilities. A corporate joint
venture also usually provides an arrangement under which each joint venturer
may participate, directly or indirectly, in the overall management of the
joint venture. Joint venturers thus have an interest or relationship other
than as passive investors. An entity that is a subsidiary of one of the
joint venturers is not a corporate joint venture. The ownership of a
corporate joint venture seldom changes, and its stock is usually not traded
publicly. A noncontrolling interest held by public ownership, however, does
not preclude a corporation from being a corporate joint venture.
To be considered a joint venture, an entity should also be jointly controlled by
its investors.
In identifying whether a transaction meets the definition of a corporate joint
venture, an entity must use judgment and consider its particular facts and
circumstances. In his remarks at the 2014 AICPA Conference on Current SEC and
PCAOB Developments, Christopher Rogers, then a professional accounting fellow in
the SEC’s Office of the Chief Accountant (OCA), reiterated the following
long-standing SEC staff view:
In evaluating joint venture
formation transactions, the staff continues to believe that joint control is
not the only defining characteristic of a joint venture. Rather, each of the
characteristics in the definition of a joint venture in Topic 323 should be
met for an entity to be a joint venture, including that the “purpose” of the
entity is consistent with that of a joint venture. [Footnotes omitted]
In addition, ASC 805-10-S99-8 notes a comment made by an SEC observer at an EITF
meeting, stating that:
The SEC staff will object to a
conclusion that did not result in the application of Topic 805 to
transactions in which businesses are contributed to a newly formed, jointly
controlled entity if that entity is not a joint venture. The SEC staff also
would object to a conclusion that joint control is the only defining
characteristic of a joint venture.
Changing Lanes
In August 2023, the FASB issued ASU 2023-05, under which an entity
that qualifies as either a joint venture or a corporate joint venture,
as defined in the ASC master glossary, is required to apply a new basis
of accounting upon the formation of the joint venture. Specifically, the
ASU provides that a joint venture or a corporate joint venture
(collectively, “joint ventures”) must initially measure its assets and
liabilities at fair value on the formation date. The amendments in ASU
2023-05 apply to the formation of all joint ventures regardless of
whether the venture meets the definition of a business in ASC 805-10.
Further, under the ASU:
- The formation of a joint venture results in the “creation of a new reporting entity,” and no accounting acquirer is identified under ASC 805. Accordingly, a new basis of accounting is established on the formation date. Paragraph BC23 of the ASU notes that this treatment is “generally consistent with other new basis of accounting models in GAAP, such as fresh-start reporting” under ASC 852.
- A joint venture measures the net assets and liabilities on the formation date, which the ASU defines as “the date on which an entity initially meets the definition of a joint venture.” Thus, the formation date is not necessarily the date on which the legal entity was formed (e.g., the assets of the joint venture may be contributed by one or both of the parties to the joint venture at a later point in time).
- A joint venture may establish a measurement period in a manner consistent with the measurement-period guidance in ASC 805-10 for business combinations when it identifies and measures the net assets received.
- The excess of the fair value of a joint venture as a whole over the net assets of the joint venture is recognized as goodwill. On the formation date, the joint venture’s measurement of its net assets should be “equal to the fair value of 100 percent of [its] equity.” Although the ASU does not preclude a joint venture from recognizing goodwill if it does not meet the definition of a business, paragraph BC48 of the ASU notes, in a manner consistent with the guidance in ASC 805-10-55-9, that “the Board does not expect that an entity that meets the definition of a joint venture will have more than an insignificant amount of goodwill if it does not already meet the definition of a business.”
- In situations in which the net assets of a joint venture exceed the venture’s fair value as a whole, the joint venture is required to recognize any “negative goodwill” as an adjustment to equity.
- The treatment of in-process research and development (IPR&D) contributed to a joint venture at formation is aligned with the treatment of IPR&D acquired in a business combination. Therefore, the joint venture should account for IPR&D as capitalized indefinite-lived intangible assets regardless of whether the R&D asset has an alternative future use.
A joint venture is required to provide specific
disclosures aimed at giving financial statement users a better
understanding of the nature and financial effect of the joint venture’s
formation in the period in which the formation occurred. Those
disclosures should include (1) a description of the joint venture’s
purpose, (2) the fair value of the joint venture on the formation date,
(3) the “amounts recognized by the joint venture for each major class of
assets and liabilities,” and (4) a “qualitative description of the
factors that make up any goodwill recognized.”
See Deloitte’s September 8, 2023, Heads Up,
as well as Deloitte’s Roadmap Equity Method Investments and Joint
Ventures for more information about identifying
joint ventures, joint venture formation transactions, and the newly
issued ASU.
2.3.2 Common-Control Transactions
A common-control transaction is similar to a business combination for the entity that receives the
net assets or equity interests; however, such a transaction does not meet the definition of a business
combination because there is no change in control over the net assets. Therefore, the accounting
and reporting for a transaction between entities under common control is outside the scope of the
business combinations guidance in ASC 805-10, ASC 805-20, and ASC 805-30 and is addressed in the
“Transactions Between Entities Under Common Control” subsections of ASC 805-50. Since there is no
change in control over the net assets from the parent’s perspective, there is no change in the parent’s
basis in the net assets. See Appendix B for more information about common-control transactions.
2.3.3 Common-Ownership Transactions
Common ownership exists when two or more entities have the same shareholders but no one
shareholder controls all of the entities. Transfers of net assets or equity interests among entities that
have common ownership are not common-control transactions. However, they may be accounted for
similarly to common-control transactions if the transfer lacks economic substance. See Appendix B for
more information about common-ownership transactions.
2.3.4 Asset Acquisitions
For an acquisition to meet the definition of a business combination, the net assets acquired must meet
the definition of a business in ASC 805-10 (see Section 2.4). The acquisition of an asset, or a group of
assets, that does not meet the definition of a business is called an asset acquisition and is accounted for
in accordance with the “Acquisition of Assets Rather Than a Business” subsections of ASC 805-50. See
Appendix C for more information about accounting for asset acquisitions.
2.3.5 Combinations of Not-for-Profit Entities
Combinations between not-for-profit entities and acquisitions of for-profit businesses by not-for-profit
entities are not within the scope of ASC 805-10, ASC 805-20, and ASC 805-30, although these subtopics
apply when a for-profit entity acquires a not-for-profit business.
The ASC master glossary defines a not-for-profit entity as follows:
An entity that possesses the following characteristics, in
varying degrees, that distinguish it from a business entity:
-
Contributions of significant amounts of resources from resource providers who do not expect commensurate or proportionate pecuniary return
-
Operating purposes other than to provide goods or services at a profit
-
Absence of ownership interests like those of business entities.
-
All investor-owned entities
-
Entities that provide dividends, lower costs, or other economic benefits directly and proportionately to their owners, members, or participants, such as mutual insurance entities, credit unions, farm and rural electric cooperatives, and employee benefit plans.
Combinations between not-for-profit entities or acquisitions of a for-profit business by a not-for-profit
entity are accounted for in accordance with ASC 958-805. In contrast to the FASB’s decision regarding
mergers of equals between for-profit entities (see Section 2.2.3), ASC 958-805 requires that entities
determine whether a combination between not-for-profit entities is a merger or an acquisition. Not-for-profit
entities apply the carryover method to account for a merger and the acquisition method to
account for an acquisition. However, ASC 805-10, ASC 805-20, and ASC 805-30 apply when a for-profit
entity acquires a not-for-profit business.
In May 2019, the FASB issued ASU 2019-06, which extends the private-company accounting alternatives on certain identifiable intangible assets and goodwill to not-for-profit entities. See Chapter 8 of this publication for more information about the accounting alternatives available to not-for-profit entities.
2.3.6 Collateralized Financing Entities
ASU 2014-13 amended ASC 805-10 to exclude from the scope of the business combinations guidance
financial assets and financial liabilities of a consolidated VIE that is a collateralized financing entity within
the scope of the guidance on collateralized financing entities in ASC 810-10. The ASC master glossary
defines a collateralized financing entity as:
A variable interest entity that holds financial assets, issues beneficial interests in those financial assets, and has
no more than nominal equity. The beneficial interests have contractual recourse only to the related assets of
the collateralized financing entity and are classified as financial liabilities. A collateralized financing entity may
hold nonfinancial assets temporarily as a result of default by the debtor on the underlying debt instruments
held as assets by the collateralized financing entity or in an effort to restructure the debt instruments held
as assets by the collateralized financing entity. A collateralized financing entity also may hold other financial
assets and financial liabilities that are incidental to the operations of the collateralized financing entity and have
carrying values that approximate fair value (for example, cash, broker receivables, or broker payables).
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.
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).
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 a 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.
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:
-
Intellectual property that could be used to develop a good or service
-
Resources that could be developed to create outputs
-
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 that guidance, 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.
As part of an acquisition, the buyer and seller may agree that the seller will provide
services to the buyer after the acquisition. 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. 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 both in 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.