To address the second part first, the accounting for the acquisition is dramatically different, depending on whether assets or a “business” is acquired. The following table summarizes some key differences.
| GROUP OF ASSETS | BUSINESS |
|---|---|
| INITIAL RECORDING | |
| Purchase price allocated among the assets purchased on a relative-value basis. No goodwill or bargain purchase element recognized. | Assets and liabilities measured at fair value individually. Goodwill or a bargain purchase element recorded when total price does not equal cumulative fair values. |
| COSTS OF ACQUISITION | |
| Capitalized (included in purchase price). | Generally expensed. |
| CONTINGENT CONSIDERATION | |
| Generally only recognized in cost of assets when probable and estimable. Subsequent changes are adjustments to cost of assets acquired. | Recognized at acquisition date at fair value, with any subsequent changes in liability recorded in earnings. |
| IN-PROCESS R&D | |
| Portion of purchase price allocated on a fair value basis and then expensed unless it has an alternative future use. | Capitalized as an indefinite-lived intangible asset until completion or abandonment of the project. |
In January 2017, the FASB issued Accounting Standards Update No. 2017-01 “Business Combinations (Topic 805) Clarifying the Definition of a Business” (ASU 2017-01 or the ASU), which is effective for nonpublic companies starting with acquisitions in calendar year 2019, although early adoption is permitted. This guidance applies to disposals of assets, as well.
ASU 2017-01, as well as previous accounting guidance, works with “a set” of transferred assets and activities being evaluated to determine if “the set” constitutes a business. The new ASU establishes an initial screening step (Step 1) that considers whether substantially all of the fair value of the gross assets acquired is concentrated in a single asset or group of similar assets. If the answer to this question is “yes”, then “the set” is not considered a business. If the answer is “no”, then “the set” is further evaluated to determine if the transaction is accounted for as the acquisition of a business or a group of assets. This “Step 2” evaluation does not significantly differ from existing guidance before ASU 2017-01.
The Step 2 further consideration consists of evaluating whether inputs, substantive processes and outputs exists. To be considered a business, the set should include an organized workforce with critical skills, and processes that cannot be easily replaced or that are considered unique or scarce.
Because the ASU added Step 1 as an initial screen, we believe that the changes to the accounting definition of a business will likely result in more acquisitions being recorded as acquisitions of assets rather than as acquisitions of a business.