IFRS 3 requires a business to include, as a minimum, an input and a substantive process that together significantly contribute to the ability to create output. Because all asset acquisitions include inputs, the existence of a substantive process is what distinguishes an asset or group of assets from a business. Entities can no longer presume that a set contains a process if the set generates revenues before and after the transaction. Further analysis is required to determine whether the set contains a substantive process.
Implementation of IFRS 3 revealed difficulties in assessing whether the acquired processes are sufficient to constitute one of the elements of a business; whether any missing processes are so significant that an acquired set of activities and assets is not a business; and, how to apply the definition of a business when the acquired set of activities and assets does not generate revenue.
In response, the IASB added guidance to help entities assess whether an acquired process is substantive. That guidance requires more persuasive evidence when there are no outputs, because the existence of outputs already provides some evidence that the acquired set of activities and assets is a business.
The new guidance provides a framework to evaluate when an input and a substantive process are present, by making a difference between transactions with outputs and those with no outputs. Outputs are defined as ‘the results of inputs and processes applied to those inputs that provide goods or services to customers, generate investment income (such as dividends or interest) or generate other income from ordinary activities’. [IFRS 3 B7]
When there are no outputs, an acquired process (or group of processes) will be considered substantive if the set includes employees with the necessary skills, knowledge or experience to perform an acquired process that is critical to the ability to develop or convert an acquired input or inputs into outputs. Entities must consider the facts and circumstances to determine whether employees perform or are capable of performing a substantive process.
If there are no outputs, an entity cannot consider an organized workforce provided by an acquired contract (i.e., an outsourced workforce) in its assessment of whether the set includes a substantive process. The Board concluded that a contractual arrangement that is not directly involved in creating outputs is not considered substantive enough for the set to be considered a business. Rather, the Board concluded that the acquired set needs to include a workforce that is actively contributing to the development of outputs. Without an employee to manage the performance of a vendor, there are inherent limitations on the processes that can be performed in a development capacity without further decision making or actions from an employee. If a set without outputs includes both employees and an outsourced workforce, entities will have to apply judgment to determine whether the employees are an organized workforce that provides a substantive process.
Entities also must evaluate the nature of inputs included in a set that is not generating outputs. The guidance defines an input as “any economic resource that creates, or has the ability to contribute to the creation of, outputs when one or more processes are applied to it.” This definition is similar to the definition in today’s guidance. A set might include elements that don’t create or have the ability to contribute to the creation of outputs. For example, while office furniture may be acquired as part of a set, it would likely not be considered an input in the analysis of whether a set that focuses on the development of technology is a business.
With outputs IFRS 3 Acquired process is substantive?
An acquired process (or group of processes) will be considered substantive when the set has outputs and includes any of the following:
- Employees that form an organized workforce or an acquired contract that provides access to an organized workforce that has the necessary skills, knowledge or experience to perform an acquired process (or group of processes) that, when applied to an acquired input, is critical to the ability to continue producing outputs
- A process (or group of processes) that, when applied to an acquired input, significantly contributes to the ability to continue producing outputs and cannot be replaced without significant cost, effort or delay in the ability to continue producing outputs IFRS 3 Acquired process is substantive?
- A process (or group of processes) that, when applied to an acquired input, significantly contributes to the ability to continue producing outputs and is considered unique or scarce
The Board concluded that a set that generates outputs before and after a transaction is more likely to include an input and substantive process than a set that is not generating outputs. Therefore, the criteria are less stringent than those for a set that isn’t producing outputs, and a substantive process can exist if any one of the above criteria are met. For example, a set that includes an automated production line could have a substantive process, even if it doesn’t include an organized workforce. IFRS 3 Acquired process is substantive?
An organized workforce provided by an acquired contract also may perform a substantive process, which differs significantly from the criteria for sets without outputs. Determining whether an organized workforce provided by an acquired contract (i.e., an outsourced workforce) performs a substantive process will require judgment. Entities should consider the substance of the arrangement, including the nature and terms of the activities performed by the outsourced workforce (i.e., whether it is performing a critical process).
Assumed contractual arrangements that are part of the set and provide for the continuation of revenue cannot provide a substantive process. The Board made this determination to emphasize that a set is not a business solely because there is a continuation of revenues. IFRS 3 Acquired process is substantive?
Organised workforce IFRS 3 Acquired process is substantive?
An acquired contract could give access to an organised workforce (for example, outsourced property management services). The entity needs to assess whether the organised workforce provides a substantive process that it controls. Factors to consider include: the service is not ancillary or minor; it would be difficult to replace the workforce; and the duration of the contract and renewal terms.
Groups of processes IFRS 3 Acquired process is substantive?
The criteria entities must apply to determine whether a substantive process exists refer to “groups of processes.” This reference emphasizes that a group of processes could be a substantive process. That is, a set could include numerous processes that are insignificant (i.e., not substantive) individually but are substantive in the aggregate.