As the economy continues to heat up, so does the merger and acquisition (M&A) market. Reuters reports that U.S. dealmaking is at a record high this year. The period from January 1 to May 28, 2015, has generated the most deals since Reuters began tracking M&A data in 1980, growing 52% over the same time period in 2014 to nearly $750 billion. Meanwhile, the Financial Accounting Standards Board (FASB) is working on two projects to simplify and clarify the accounting rules that relate to business combinations, which may be good news for companies with future M&A aspirations.
Defining a business
In May, the FASB continued its work on refining the definition of a business to help accountants distinguish between transactions that should be treated as acquisitions (or disposals) of assets and acquisitions (or disposals) of businesses. The distinction is important because, if a business buys or acquires another business, it must follow FASB Accounting Standards Codification (ASC) Topic 805, Business Combinations. But that standard doesn’t apply to acquisitions of assets.
Sometimes it’s easy to define what’s being transferred. Other times transactions are less straightforward. For example, questions may arise in real estate deals or when a company purchases the rights to new drug patents that involve hiring the scientists who developed them.
In May 2013, the FASB’s project to define a business started as a way to clarify the application of the asset- or entity-based guidance for the nonfinancial assets in an entity. In October 2014, the board realized it had to first clarify the definition of a business.
In December 2014, the FASB decided that a set of activities and assets must include “inputs” and one or more substantive processes that contribute to the ability to create “outputs” to be considered a business. Inputs can include people, money, raw materials, finished goods and other economic resources that create — or have the ability to create — goods or services. Outputs are simply goods or services produced for customers.
Challenging the status quo
This clarification represents a significant change from current guidance, which doesn’t require a business to include the production of goods or services — it just calls for there to be inputs and processes in place. ASC 805 explains what it takes for a group of assets to be considered a business, but the standard doesn’t specify what types of inputs or processes are required.
In May 2015, the FASB agreed to make the guidance even simpler by creating an initial test to help entities determine whether they pass or fail the definition of a business. The test, or threshold, would provide a practical way to evaluate whether a transferred set of activities is an asset or a business. In order for a set of activities to be considered an asset — as opposed to a business — “substantially all” of the fair value from the activities would need to be represented by a single tangible or identifiable, intangible asset.
In the coming months, the FASB plans to develop examples that will help in making the distinction for a possible proposed amendment to U.S. Generally Accepted Accounting Principles. The board also agreed to develop a framework for when inputs and processes together “substantively” contribute to the ability to create outputs. The framework would include several factors to help make the distinction between a business and a nonbusiness.
Providing long-awaited guidance
Over the years, the FASB has polled businesses about the existing guidance on how to report acquisitions and dispositions. Although defining a business may initially seem to be a matter of semantics, public feedback indicates that businesses exert significant effort to make the determination between whether an asset or a business has been transferred. Many companies welcome additional guidance to help simplify the decision.
Sidebar: Proposed changes to financial statement adjustments in M&A
In May 2015, the Financial Accounting Standards Board (FASB) released Proposed Accounting Standards Update (ASU) No. 2015-260, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments, to simplify the financial reporting requirements for mergers and acquisitions (M&As).
FASB Accounting Standards Codification (ASC) Topic 805, Business Combinations, lets acquirers in a business combination set provisional amounts for line items that can’t accurately be determined at the end of the fiscal year or quarter. Businesses have told the FASB that the process of revising these provisional amounts as new information becomes available is too costly to justify getting the information to investors.
Under the proposed changes, provisional amounts would still be adjusted when new information arises, but the adjustments would no longer need to be done retrospectively. The FASB has proposed that adjustments caused by depreciation or amortization would be done as if the accounting had been completed when the acquisition closed. Any changes would be reflected in earnings for the period the adjustments are made.