In May 2019 amendments to IFRS 3 Business Combinations were published by IASB. See the introduction in Redefinition of a business.
IFRS 3 continues to adopt a market participant’s perspective to determine whether an acquired set of activities and assets is a business. The amendments: clarify the minimum requirements for a business; remove the assessment of whether market participants are capable of replacing any missing elements; add guidance to help entities assess whether an acquired process is substantive; narrow the definitions of a business and of outputs; and introduce an optional fair value concentration test. Overview of the amendments IFRS 3 Business Combinations
Minimum requirements to be a business Overview of the amendments IFRS 3 Business Combinations
In the IASB’s view, the existence of a process (or processes) is what distinguishes a business from a non-business. Consequently, the Board decided that to be considered a business, an integrated set of activities and assets must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output. It also clarified that a business can exist without including all of the inputs and processes needed to create outputs. That is, the inputs and processes applied to those inputs must have the ‘ability to contribute to the creation of outputs’ rather than the ‘ability to create outputs’.
Market participant’s ability to replace missing elements Overview of the amendments IFRS 3 Business Combinations
Prior to the amendments, IFRS 3 stated that a business need not include all of the inputs or processes that the seller used in operating that business, “if market participants are capable of acquiring the business and continuing to produce outputs, for example, by integrating the business with their own inputs and processes”. The IASB, however, decided to base the assessment on what has been acquired in its current state and condition, rather than on whether market participants are capable of replacing any missing elements, for example, by integrating the acquired activities and assets. Therefore, the reference to such integration was deleted from IFRS 3. Instead, the amendments focus on whether acquired inputs and acquired substantive processes together significantly contribute to the ability to create outputs.
Assessing whether an acquired process is substantive Overview of the amendments IFRS 3 Business Combinations
Implementation of IFRS 3 also 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 Board also reasoned that, although itself an input, the presence of an organised workforce is an indicator of a substantive process. This is because the ‘intellectual capacity’ of an organised workforce having the necessary skills and experience following rules and conventions may provide the necessary processes (even if not documented) that are capable of being applied to inputs to create outputs.
The amendments to IFRS 3 specify that if a set of activities and assets does not have outputs at the acquisition date, an acquired process shall be considered substantive only if: (a) it is critical to the ability to develop or convert acquired inputs into outputs; and (b) the inputs acquired include both an organised workforce with the necessary skills, knowledge, or experience to perform that process and other inputs that the organised workforce could develop or convert into outputs. In contrast, if a set of activities and assets has outputs at that date, an acquired process shall be considered substantive if: (a) it is critical to the ability to continue producing outputs and the acquired inputs include an organised workforce with the necessary skills, knowledge, or experience to perform that process; or (b) it significantly contributes to the ability to continue producing outputs and either is considered unique or scarce, or cannot be replaced without significant cost, effort or delay in the ability to continue producing outputs.
The Board also added some clarifications to IFRS 3 to support these requirements, including that an acquired contract is not itself a substantive process. An acquired contract, such as a contract for outsourced property management or outsourced asset management, may however give access to an organised workforce.
Narrowed definition of outputs Overview of the amendments IFRS 3 Business Combinations
Previously, outputs were defined as returns in the form of dividends, lower costs or other economic benefits provided directly to investors or other owners, members or participants. As part of the amendments to IFRS 3, the IASB narrowed the definition of outputs to focus on goods or services provided to customers, investment income (such as dividends or interest) or other income from ordinary activities. The definition of a business in Appendix A of IFRS 3 was amended accordingly.
According to the Board, the previous reference to lower costs and other economic benefits provided directly to investors did not help to distinguish between an asset and a business. For example, many asset acquisitions may be made with the motive of lowering costs but may not involve acquiring a substantive process. Therefore, this wording was excluded from the definition of outputs and the definition of a business.
A new item, the introduction of a optional concentration test to simplify the decision process on whether a business or (group of) identifiable asset(s) was acquired is explained in the link.