Real estate – definition of a business (1)
Company A acquires land and a vacant building from Company B. No processes, other assets or employees
(for example, leases and other contracts, maintenance or security personnel, or a leasing office) are acquired
in the transaction.
Inputs – land and vacant building
Processes – none
Output – none
Conclusion
In this scenario, we do not believe Company A acquired a business. While Company A acquired inputs (land
and a vacant building), it did not acquire any processes. Whether or not a market participant has the necessary
processes in place to operate the inputs as a business is not relevant to the determination of whether the
acquired set is a business, because no processes were acquired from Company B.
Example 9.4:
Real estate – definition of a business (2)
Company A acquires an operating hotel, the hotel’s employees, the franchise agreement, inventory,
reservations system and all ‘back office’ operations.
Inputs – non-current assets, franchise agreement and employees
Processes – operational and resource management processes associated with operating the hotel
Output – revenues from operating the hotel
Conclusion
In this scenario, we believe Company A acquired a business. The acquired set has all three components of a
business (inputs, processes and outputs) and is capable of providing a return to its owners.
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Sometimes it may be difficult to determine whether or not an acquired group of assets
is a business, and judgement will be required to be exercised based on the particular
circumstances. The determination of whether or not an acquired group of assets and
activities is a business can have a considerable impact on an entity’s reported results
and the presentation of its financial statements. Differences between a business
combination and an asset(s) acquisition are summarised at 2.2.2 above.
3.2.4
Development stage entities
Development stage entities may qualify as businesses, and their acquisition accounted
for as business combinations because outputs are not required at the acquisition date.
Inputs and processes are not required either if a market participant has access to the
necessary inputs or processes or the missing elements are easily replaced. However, we
believe that, in most cases, the acquired set of activities and assets must have at least
some inputs and processes in order to be considered a business. Various factors need
to be considered to determine whether the transferred set of activities and assets is a
business, including, but not limited to, the following:
(a) whether the entity has begun its planned principal activities;
(b) whether it has employees, intellectual property and other inputs and processes
that could be applied to those inputs;
(c) if it is pursuing a plan to produce outputs; and
(d) if it will be able to obtain access to customers that will purchase the outputs. [IFRS 3.B10].
This list of factors should not be considered a checklist; there is no minimum number of
criteria that need to be met when determining if a development stage entity is a business.
The primary consideration is whether the inputs and processes acquired, combined with
the inputs and processes of a market participant are capable of being conducted and
managed to produce resulting outputs. We believe that the further an acquired set of assets
and activities is in its life cycle, the more difficult it will be to conclude a market participant
is not capable of operating the acquired set as a business. For example, if the planned
operations of an acquired set of assets and activities have commenced, we generally
believe that this would represent a business, as would acquired activities and assets
including employees and intellectual property that are capable of producing products.
The application of this guidance may be particularly relevant to transactions in the life
sciences industry. This is illustrated in the following examples.
Example 9.5:
Life sciences – definition of a business (1)
Biotech A acquires all of the outstanding shares in Biotech B, which is a development stage company with a
licence for a product candidate. Due to a loss of funding, Biotech B has no employees and no other assets.
Neither clinical trials nor development are currently being performed. When additional funding is obtained,
Biotech A plans to commence phase I clinical trials for the product candidate.
Input – licence to product candidate
Processes – none
Outputs – none
Conclusion
In this scenario, we do not consider that Biotech A has acquired a business. While Biotech B has an input (licence),
it lacks processes to apply to the licence in order to create outputs. Furthermore, Biotech B has no employees and
is not pursuing a plan to produce outputs (no research and development is currently being performed).
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Example 9.6:
Life sciences – definition of a business (2)
Biotech C acquires all of the outstanding shares in Biotech D, a development stage company that has a licence
for a product candidate. Phase III clinical trials are currently being performed by Biotech D employees (one
of whom founded Biotech D and discovered the product candidate). Biotech D’s administrative and
accounting functions are performed by a contract employee.
Inputs – licence for product candidate and employees
Processes – operational and management processes associated with the performance and supervision of the
clinical trials
Output – none
Conclusion
In this scenario, we consider that Biotech C has acquired a business because it has acquired inputs and
processes. Biotech D has begun operations (development of the product candidate) and is pursuing a plan to
produce outputs (i.e. a commercially developed product to be sold or licensed).
3.2.5 Presence
of
goodwill
There is a rebuttable presumption that if goodwill arises on the acquisition, the
acquisition is a business. [IFRS 3.B12]. If, for example, the total fair value of an acquired
set of activities and assets is $15 million and the fair value of the net identifiable assets
is only $10 million, the existence of value in excess of the fair value of identifiable assets
(i.e. goodwill) creates a presumption that the acquired set is a business. However, care
should be exercised to ensure that all of the identifiable net assets have been identified
and measured appropriately. While the absence of goodwill may be an indicator that
the acquired activities and assets do not represent a business, it is not presumptive.
[IFRS 3.B12].
An acquisition of a business may involve a ‘bargain purchase’ in which the new bases of
the net identifiable assets are actually greater than the fair value of the entity as a whole
(see 10 below).
3.2.6
Proposed clarifications to the definition of a business
In June 2016, in response to stakeholder concerns raised during the PIR of IFRS 3, the
IASB proposed amendments that aim to clarify how to
apply the definition of a business
in IFRS 3. The proposed amendments aim to provide additional guidance to help
distinguish between the acquisition of a business and the acquisition of a group of assets.
The FASB also issued a proposal10 in response to similar feedback in its PIR regarding
difficulties in applying the definition of a business. The FASB and the IASB jointly
discussed the clarifications to the definition of a business in IFRS 3 and the FASB’s
Accounting Standards Codification (ASC) 805. In January 2017, the FASB concluded its
project and issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the
Definition of a Business.
At the time of writing, the IASB had not yet finalised its amendments to IFRS 3 on the
definition of a business, but at its meeting in October 2017, the IASB concluded that the
due-process steps required to issue a narrow-scope amendment have been completed
and tentatively decided not to re-expose the amendments to IFRS 3.11 The IASB expects
to issue its amendments in the second half of 2018.12 The IASB’s proposed amendments,
including recent updates, are discussed below.
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• The fair value of the assets acquired is concentrated in a single asset or a group of
similar identifiable assets
The ED proposes a screening test designed to simplify the evaluation of whether
an integrated set of activities and assets constitutes a business. Under the proposed
amendments, an integrated set of activities and assets is not a business 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 proposed
screening test is based on the fair value of the gross assets acquired, rather than
the fair value of the total consideration paid or the net assets. Thus, the significance
of a single asset or a group of similar assets acquired is assessed without
considering how they are financed.
If this screening test indicates that an integrated set of activities and assets is not a
business, then an entity would not have to evaluate the other guidance included in
the definition of a business.13
In light of the feedback received, the IASB tentatively decided in April and
October 2017 to:14
• clarify that an entity is permitted, but not required, to carry out the screening
test on a transaction-by-transaction basis;
• specify that if the screening test identifies an asset purchase, no further
assessment is needed (although the entity is not prohibited from carrying out
such further assessment);
• clarify that if the screening test does not identify an asset purchase, the entity
must carry out a further assessment. (If the entity elected not to apply the
screening test, it must carry out that same assessment.)
• specify that the gross assets considered in the screening test should exclude
cash and cash equivalents acquired, deferred tax assets and goodwill resulting
from the effects of deferred tax liabilities;
• clarify that guidance on ‘a single asset’ for the screening test also applies when
one of the acquired assets is a right-of-use asset, as described in IFRS 16,
which is considered together with the asset to which it relates (for example
leasehold land and the building on it are a single asset for the screening test);
• clarify that when assessing whether assets are ‘similar’ for the screening test,
an entity should consider the nature of each single asset and the risks
associated with managing and creating outputs from the assets; and
• clarify that the new guidance on what assets may be considered a single asset
or a group of similar assets is not intended to modify the existing guidance on
similar assets in paragraph 36 of IAS 38 and the term ‘class’ in IAS 16, IAS 38
and IFRS 7 – Financial Instruments: Disclosures.
• Minimum requirements to be a business
The IASB decided that in order to be considered a business, an acquisition must
include, at a minimum, an input and a substantive process that together have the
ability to contribute to the creation of outputs. However, not all of the inputs and
processes necessary to create outputs have to be acquired for the integrated set of
Business
combinations
607
activities and assets to qualify as a business.15 In June 2017, the IASB tentatively
decided to clarify that to be considered a business an acquired set of activities and
assets must include, at a minimum, an input and a substantive process that together
are required to contribute significantly to the ability to create outputs.16
• Evaluating whether the acquired process is substantive
The ED proposes guidance to assist entities in determining whether a substantive
process has been acquired. The proposed amendments include different criteria
for consideration, depending on whether the acquired integrated set of assets and
activities has outputs. When it does not, at the acquisition date, have outputs, then
the definition of a business is met only if the inputs acquired include both an
organised workforce that performs a process that is critical to the creation of
outputs and another input (or inputs) that is intended to be developed into outputs.
In contrast, when the acquired set of activities and assets at the acquisition date
has outputs, an organised workforce is not required if the acquired set includes a
process (or group of processes) that is unique or scarce or is difficult to replace.17
In June 2017, the IASB tentatively decided to confirm the guidance proposed in
the ED to assess whether a substantive process has been acquired. In addition, the
IASB tentatively decided to specify that difficulties in replacing an acquired
workforce may indicate that the workforce performs a substantive process.18
• Market participant capable of replacing missing elements
The IASB decided that the ability of a market participant to replace any missing
elements by integrating the acquired set of activities and assets into its own and
continuing to produce outputs is no longer a consideration in determining whether
the acquisition is a business combination.19 The Board believes that the assessment
should be based on what has been acquired, rather than what a market participant
could replace.20
• Revise the definition of outputs
The ED proposes to narrow the definition of outputs to focus on goods and
services provided to customers and ‘other revenues’. Thus, the proposed
definition excludes returns in the form of lower costs and other economic benefits
provided directly to investors or other owners, members, or participants.21 The
IASB believes that the current definition of outputs does not sufficiently
distinguish between an asset and a business. For example, many asset acquisitions
(e.g. the purchase of new equipment for a manufacturing facility) may result in
lower costs even though they do not involve the acquisition of activities and
processes.22 In June 2017, the IASB tentatively decided to clarify that ‘other
revenues’ includes income arising from contracts that are within the entity’s
&
nbsp; ordinary activities but are outside the scope of IFRS 15. In addition, the IASB
tentatively decided that if an acquired set of assets generated revenues before the
acquisition, but is integrated by the acquirer and no longer generates revenues
after the acquisition, that set of assets is regarded as creating outputs.23
The ED also proposes to clarify that an acquired contract is not a substantive process.
However, an acquired outsourcing agreement may provide access to an organised
workforce that performs a substantive process.24
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• Goodwill
The ED proposed removing from paragraph B12 of IFRS 3 the statement that a set of
assets and activities in which goodwill is present is presumed to be a business. The ED
also states that the presence of goodwill may be an indicator that a business has been
acquired. However, the presence of an insignificant amount of goodwill does not mean
that the acquired assets (and activities, if any) should automatically be considered a
business.25 As discussed in 2.2.2 above, the acquisition of an asset or a group of assets (and
activities, if any) that do not constitute a business, does not give rise to goodwill. If the
consideration paid exceeds the fair value of the individual assets and liabilities acquired
in an asset acquisition, the cost of the group is allocated to the individual identifiable assets
and liabilities on the basis of their relative fair values at the date of purchase. [IFRS 3.2].
The Board also proposes to add illustrative examples to IFRS 3 to assist with the
interpretation of what is considered a business.26 However, in October 2017, the IASB
tentatively decided to remove the proposed Illustrative Example J Acquisition of oil and
gas operations.
The ED proposes that an entity would be required to apply the proposed amendments
to IFRS 3 to any business combination for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after the effective date of
the amendments.27 In October 2017, the IASB tentatively decided that the amendments
to IFRS 3 should apply for business combinations for which the acquisition date is on
or after the beginning of the first annual reporting period beginning or after
1 January 2020, with earlier application permitted.28
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