The advancement of digital technology has forced many companies to think more deeply about what kind of business they really are in, but it’s only now that finance departments are being given a better definition of what the word “business” really means.
Late last month, the Financial Accounting Standards Board (FASB) released a call for comments on its proposal to clarify the definition of “business”, focusing on the difference between a business and an asset.
The FASB suggested that such guidance is long overdue:
“The definition of a business affects many areas of accounting, including acquisitions, disposals, goodwill impairment, and consolidation. However, many stakeholders have said that the current definition of a business is applied too broadly, requiring many transactions to be treated as businesses when they should be treated as assets. They also noted that analyzing such transactions is costly and complex.”
In other words, the FASB would define a true business as an entity that can make products, offer services and generate revenue with its own processes and resources. When a company buys something like a manufacturing plant, on the other hand, it might only be an asset because the company may need to buy other resources or systems for the plant to function successfully.
An End to ‘Business as Usual’?
If the FASB’s definition gets industry support, the ramifications for budgeting, planning, forecasting and reporting could be huge. As a story on AccountingWeb noted, there are so many gray accounting areas today that make financial reporting more complex, time-consuming and costly.
“A set of assets and activities may qualify as a business even if no processes are included in the transaction when revenue-generating activities continue after an acquisition,” the story said. “For example, in the real-estate industry, a market participant often is capable of acquiring inputs, such as a building with leases, and combining them with its own processes to continue generating outputs (lease income).”
Experts told CFO Magazine, meanwhile, that the definition could avoid accounting misstatements with the bonus of not having to go through appraisals or an evaluation of goodwill when purchasing an asset versus a business.
“If a company incurs a transaction cost to buy an asset with a lengthy lifespan, it can spread out the cost for years – thereby maximizing its current profits,” CFO Magazine noted.
Of course, such changes are never easy or quick. The FASB is asking organizations to review and comment on the proposal between now and Jan. 22, 2016 before it goes any further. There will no doubt be detailed discussions on what constitutes an input, an output or a process, among other areas.
Overall, though, it’s encouraging to see this important conversation begin because, as with anything else related to corporate performance management, having a common understanding of what things mean translates into better data and ultimately, better decision-making.