What is Business: Amended IFRS 3

As we know, there has been an amendment to IFRS 3 regarding what we consider as the acquisition of the business and what is meant by the addition of an asset. In the article below we will discuss what has been changed.

Amended Definition

Outputs are the result of inputs and processes applied to those inputs that provide goods or services to customers, that generate investment income or other income from ordinary activities.

Example outputs cover manufactured retail goods, dividends, and interest.

The amendment narrowed the definition of outputs to exclude returns in the form of lower costs, and other economic benefits provided directly to investors or other owners, members, or participants.

Example outputs include: manufactured retail goods, dividends, and interest.

The amendment narrowed the definition of outputs to exclude returns in the form of lower costs, and other economic benefits provided directly to investors or other owners, members, or participants.

The two essential components of a business are the input and the substantive process and as a result, the presence of outputs is not necessary to meet the definition of a business. Whether the acquired inputs and processes can contribute to the ability to create outputs determines whether the set of activities and assets acquired meet the definition of a business.

Substantive Process

A process is any system, standard, protocol, convention, or rule that when applied to inputs, creates outputs or can contribute to the creation of outputs.

Example processes include: strategic management process, operational process, and resource management processes.

The amendment introduced guidance that helps determine whether an acquired process is substantive, the criteria for which are dependent on the existence of outputs at the acquisition date.

Current state and condition of obtained set

Before the amendments, IFRS 3 stated that a business did not need to include all of the inputs or processes that the seller used in operating the business if market participants were capable of acquiring the business and continuing to produce outputs (e.g., by integrating the business with their own inputs and processes). This reference was removed.

The assessment is now based on what has been acquired in its current state and condition, rather than whether market participants would be capable of replacing any missing inputs or processes.

Business or asset acquisition?

To determine whether a transaction is a business or an asset acquisition, an entity must assess whether the two minimum business definition requirements (an input and a substantive process) are met.

Organized workforce

An organized workforce is an input to a business, and its presence is an indicator of a substantive process.

If the acquired set of assets and activities does not have outputs at the acquisition date, its inputs must include an organized workforce in order for the set to meet the definition of a business. It must also include a substantive process.

As a result, the specific criteria used to determine whether a process is substantive (and ultimately whether a transaction is a business combination) differs based on whether outputs exist at the acquisition date.

We look at these circumstances next.

Outputs exist

If an acquired set of assets and activities is generating revenue at the acquisition date, outputs exist.

Where outputs exist at the acquisition date, an acquired process is substantive if either of the following has been acquired:

1. A process that is critical to the ability to continue producing outputs and inputs that include an organized workforce with the skills, knowledge, or experience to perform the acquired process;

OR 2.

• process that significantly contributes to the continuing production of outputs that is:
• Unique or scarce; or
• Cannot be replaced without significant cost, effort, or delay.

Organized workforce

What is the importance if acquiring an organized workforce in these criteria?

Remember, an organized workforce is an input. Difficulties in replacing the workforce may indicate that a substantive process has also been acquired. The intellectual capacity of an organized workforce with the necessary skills and experience following rules and conventions may provide the processes capable of being applied to inputs to create outputs. Where this exists, together with outputs existing at acquisition date, the acquired process is substantive.

Without an organized workforce with the necessary skills and experience, limited circumstances allow for the process acquired to be substantive. To be considered substantive, the process must significantly contribute to output production and must be unique or scarce or not easily replaced without significant cost.

Although the criteria focus on a substantive process, we also know an input is present as it is being converted into outputs (revenue) at the acquisition date.

No outputs exist

Where no outputs exist, more persuasive evidence is needed to conclude there is an acquisition of a business.

An example where no outputs exist is an early development stage entity that has not yet generated revenue.

Criteria

When no outputs exist at the acquisition date, an acquired process is substantive if both of the following have been acquired:

1. A critical process to develop or convert acquired input(s).

(Accounting, billing, payroll, and other administrative systems are not critical processes used to create outputs);

AND

2.

• Inputs including both:
• An organized workforce with the necessary skills, knowledge, or experience to perform that critical process; and
• Other inputs that the workforce could develop or convert into outputs.

Organized workforce

The criteria for a business combination where no outputs exist are the same: the acquired set must include inputs and a substantive process. However, to conclude that a substantive process has been acquired, the input acquired must include an organized, qualified workforce that will perform that process (along with at least one other input to be developed or converted by the workforce).

Why?

Remember, an organized workforce is an input. Where no outputs exist at the acquisition date- an organized workforce is needed (in addition to at least another input and a substantive process to conclude that a business has been acquired.

Other considerations

Assessing whether a transaction is a business combination or an asset acquisition will often require judgment and an assessment of all the facts and circumstances of the arrangement.

Further assessment considerations

Other considerations related to this assessment include:

• is an input and not a substantive process. This includes contracts that provide a continuing revenue stream (e.g., a lease contract, customer contracts, and supply arrangements).
• An acquired contract may give access to an organized workforce and entities should assess whether the workforce performs a substantive process and whether the entity controls what the workforce performs. For example, a contract may provide access to property or asset management, which (depending on the facts and circumstances) may be considered a substantive process. Factors to be considered in the assessment include the duration of the contract and its renewal terms.
• An organized workforce may perform a process. Difficulty in replacing the workforce may indicate that the process acquired is substantive.
• A process(s) is not critical if it is minor or secondary compared to all the processes required to create outputs.