IFRS 3 Amendments - Definition of a Business

Project History

The Post Implementation Review (PIR) of IFRS 3 Business Combinations concluded that the definition of a business is one of the top four concerns with IFRS 3.

In February 2015, the IASB discussed the issues arising from the PIR of IFRS 3 and decided that more work on the definition of a business would be justified. Therefore, the IASB added the topic to its research agenda.

The objective of this project is to improve the application of the definition of a business in order to resolve the difficulties that arise in practice when an entity is determining whether it has acquired a business or a group of assets. The US Financial Accounting Standards Board (FASB) is working on a similar project with a similar objective. At their joint meeting in September 2015, the IASB and the FASB discussed the project summaries presented by the IASB and the FASB staff, including the FASB's tentative decisions on how to clarify the definition of a business and related application guidance.

In October 2015, the IASB discussed an analysis of the FASB's proposals on how to improve the application of the definition of a business and decided to propose changes to IFRS 3 that are the same as the amendments proposed by FASB.

Exposure Draft

On 28 June 2016 the IASB published the Exposure Draft ED/2016/1 Definition of a Business and Accounting for Previously Held Interests. The objective of the narrow-scope amendments to IFRS 3 and IFRS 11 Joint Arrangements is to provide clearer application guidance to help distinguish between a business and a group of assets when applying IFRS 3; and clarify how a company should account for previously held interest in a business, if acquiring control, or joint control, of that business.

EFRAG's Comment Letter

On 27 July 2016 EFRAG published its Draft Comment Letter in response to the IASB's Exposure Draft, requesting comments by 18 October 2016.

On 9 November 2016, EFRAG published its final comment letter on the IASB's Exposure Draft.

In its final comment letter, EFRAG welcomes the IASB's efforts to provide clarity on the definition of a business, and to help distinguish between a business and a group of assets. The proposals respond to concerns expressed by many stakeholders that the definition in IFRS 3 Business Combinations is too broad and lacks guidance on what should not be considered a business. This has resulted in a number of acquisitions being treated as business combinations which, in the view of the preparers, should have been treated as 'asset acquisitions'.

EFRAG noted the difficulties in drafting a screening test that is easy to apply, that the screening test addresses concerns that the existing definition of a business captures some asset acquisitions and reaches the appropriate conclusion in every possible set of facts and circumstances. However, EFRAG was concerned that, as currently drafted, the screening test may, in some instances, result in inappropriate conclusions. EFRAG considered that the screening test should be retained as a determinative assessment only if its relative simplicity can be maintained while avoiding inappropriate outcomes. Should the IASB decide to retain the screening test in the proposed form, EFRAG stated a number of concerns that should be addressed.

In respect of the proposed guidance on evaluating whether an acquired process is substantive, EFRAG agreed with having two different sets of criteria depending on whether the set of activities and assets has outputs. However, EFRAG had some concerns about the presence of goodwill as an indicator, the guidance on acquired contracts and the role of an organised workforce.

EFRAG agreed that examples are important in illustrating the application of the principles in the proposed guidance. However, EFRAG recommended that the examples focus more on the areas of the guidance that require significant judgement and EFRAG provided detailed comments on the proposed illustrative examples.

Further, EFRAG encouraged the IASB and the FASB to reach converged solutions on their respective proposed amendments and use similar wording wherever possible in order to avoid divergence in practice.

Finally, while welcoming the IASB's efforts to provide clarity, EFRAG also observed that the tension arising from the distinction between business combinations and asset acquisitions originates to a significant degree from differences in the accounting. EFRAG therefore recommended that in due course the IASB should analyse whether or not these accounting differences are justified by differences in the economic substance of the two classes of transaction.

In response to the amendments on accounting for previously held interests, EFRAG supported the IASB's proposals to clarify the accounting for previously held interests in the assets and liabilities of a joint operation in the two types of transactions addressed in the ED.

Finally, in relation to the transition requirements, EFRAG agreed that the proposals should be applied prospectively.

IASB tentative decisions

The IASB discussed feedback received from respondents on the ED at its meetings in April, June and October 2017.  

In summary, the IASB has tentatively decided to:

1. clarify the description of the screening test as follows:
   1. an entity is permitted, but not required, to carry out the screening test;
   2. if the screening test identifies an asset purchase, no further assessment is needed (although the entity is not prohibited from carrying out such further assessment); and
   3. if the screening test does not identify an asset purchase, the entity must carry out a further assessment. (If the entity elected not to apply the screening test, it must carry out that same assessment.)

2. remove the proposed Illustrative Example J Acquisition of oil and gas operations;

3. clarify that to be considered a business an acquired set of activities and assets must include, at a minimum, an input and a substantive process that together are required to contribute significantly to the ability to create outputs;

4. reaffirm the proposal to remove the following text from paragraph B8 of IFRS 3 Business Combinations: "However, 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";

5. reaffirm the proposal to amend the definition of ‘output’ by removing the reference to the ability to reduce costs, and clarifying that ‘other revenues’ means other income arising from contracts that are within the entity’s ordinary activities but are outside the scope of IFRS 15 Revenue from Contracts with Customers;

6. clarify that if an acquired set of assets generated revenues before the acquisition, but is integrated by the acquirer and no longer generates revenues after the acquisition, that set of assets is regarded as creating outputs;

7. confirm the guidance proposed in the ED to assess whether a substantive process has been acquired, including the guidance on acquired outsourcing agreements, and to specify in the guidance on substantive processes that difficulties in replacing an acquired workforce may indicate that the workforce performs a substantive process;

8. specify that the gross assets considered in the screening test exclude cash and cash equivalents acquired: goodwill resulting from the effects of deferred tax liabilities; deferred tax assets;

9. specify that the amendments to IFRS 3 should apply for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning or after 1 January 2020, with earlier application permitted.

Final amendments

​On  22 October 2018, the IASB issued  the amendments to its definition of a business. The amendments retain most of the proposals in the exposure draft.  The changes are effective from 1 January 2020, but entities can decide to apply them earlier.

Draft endorsement advice

On 14 January 2019 EFRAG issued a draft endorsement advice letter and a separate invitation to comment relating to the endorsement for use in the EU of the Amendments.

Final endorsement advice

On 28 March 2019 EFRAG issued its final endorsement advice, reiterating the assessment made in the draft endorsement advice letter that the Amendments meet all the technical endorsement criteria of the IAS Regulation and are conducive to the European public good. EFRAG has therefore recommended their endorsement.