On January 5, 2017, the Financial Accounting Standards Board (FASB) published guidance to clear up the existing rules for determining whether the purchase (or sale) of an asset or group of assets qualifies as the purchase (or disposal) of a business. Here’s what’s changing under the updated guidance and why the changes are needed.
Critics have long complained that the current definition of a business is overly broad and captures too many day-to-day purchases of assets, requiring businesses to follow the complex rules for business combinations under existing U.S. Generally Accepted Accounting Principles (GAAP).”
Stakeholders expressed concerns that the definition of a business is applied too broadly and that many transactions recorded as business acquisitions are, in fact, more akin to asset acquisitions,” FASB Chairman Russell Golden said in a statement. ”
The new standard addresses this by clarifying the definition of a business while reducing the cost and complexity of analyzing these transactions.”Accounting Standards Update (ASU) No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, revises the definition of “business.” The change is expected to reduce the number of transactions that qualify as business combinations vs. routine deals involving assets.
The new definition lays out new minimum requirements for a set of assets to be considered a business. A set must, at minimum, include an “input” and a substantive process that together significantly contribute to create outputs. Inputs can include people, intellectual property or raw materials. The standard provides guidance to determine whether both an input and a substantive process are present.
The standard also includes two sets of criteria to consider whether a set has outputs. Although outputs aren’t required for an asset set to be a business, outputs generally are a key element of a business. Outputs typically are considered goods or services for customers that provide (or have the ability to provide) a return to the business’s investors in the form of dividends, lower costs or other economic benefits.
In addition, the update provides a screen, or shortcut, to help accountants make a quick call about when a set of assets isn’t a business. The screen requires that, when substantially all the fair value of the gross assets acquired (or disposed of) is concentrated in a single asset or a group of similar identifiable assets, the set isn’t a business.
Public companies must follow the new guidance for annual periods beginning after December 15, 2017, including interim periods within those fiscal years. Privately held companies must adhere to the new definition for fiscal years beginning after December 15, 2018, and interim periods within fiscal years that begin after December 15, 2019. Early application is permitted under certain circumstances. Contact your CPA for additional details.
The Financial Accounting Standards Board (FASB) considers Accounting Standards Update (ASU) No. 2017-01 to be the first phase of its broader effort to sharpen the difference between the acquisition (or sale) of a business and the acquisition (or sale) of a group of assets.
In June, the FASB released what it considers phase two: Proposed ASU 2016-250, Other Income — Gains and Losses From the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets. The update clarifies how to account for sales and disposals of nonfinancial assets, such as real estate.
The planned amendments would typically apply to contracts “in which substantially all of the fair value of the assets promised to a counterparty is concentrated in nonfinancial assets” and subsidiaries “in which substantially all of the fair value of the assets in the subsidiary is concentrated in nonfinancial assets.” The FASB expects to publish a final update in the coming months.
Today, many companies operate in more than one country, requiring them to comply with multiple sets of rules and regulations. This can sometimes be challenging for businesses and their advisors. Case in point: Some auditors who are registered with the Public Company Accounting Oversight Board (PCAOB) have been uncertain whether they’re required to present audit working papers and other documentation to the PCAOB in light of a 2015 rule issued by the Chinese Ministry of Finance (MOF) that bars audit firms from transmitting documents overseas.
On December 31, 2016, the PCAOB responded to these concerns, confirming that auditors who are registered with it must, indeed, comply with PCAOB document presentation rules. The recent PCAOB guidance helps auditors and their clients better understand the board’s expectations — but it could also lead to more conflicts in the future.
In 2015, the Chinese MOF issued Interim Provisions on Auditing Operations Conducted by Accounting Firms Concerning the Overseas Listing of Domestic Chinese Companies to help prevent inadvertent disclosure of state secrets. The rule prevents audit working papers from being transmitted overseas and, instead, requires them to stay in mainland China. These rules don’t apply to the work done by the mainland affiliates of the Big Four, but they do apply to Hong Kong firms signing off on work done by a mainland firm.
Despite several years of negotiations, the PCAOB doesn’t have an agreement with Chinese authorities to regularly inspect firms whose clients trade on U.S. markets. Chinese officials fear that allowing foreign inspection may infringe on China’s sovereignty.
To help clarify matters, the PCAOB recently issued Staff Questions and Answers: Audits of Mainland China Issuers by Registered Firms Outside of Mainland China. The guidance explains how the Chinese MOF rule affects PCAOB-registered auditors from outside of China that do audit work there.
The four-page staff document says that, despite the MOF’s 2015 rule, an audit firm registered with the PCAOB, without exception, must provide audit working papers and other documents in connection with board inspections and investigations.”
The PCAOB will expect the firm to ensure that the materials are completely and unconditionally produced to the PCAOB by the PCAOB prescribed deadline,” the staff Q&As say. “The board has stated that non-U.S. legal obstacles do not create an exception to a registered firm’s obligation to provide documents and other information to the board, and they are not a defense to board disciplinary action for noncooperation, including potentially revocation of a firm’s PCAOB registration.”
Moreover, the staff Q&As stress that an audit firm shouldn’t expect relief from compliance with PCAOB requests for documents or other information. Auditors should consider this guidance when considering accepting or continuing engagements.
The PCAOB interpretive guidance also deals with more technical matters. One question asks whether, if a firm does an audit with a non-U.S. accounting firm, the non-U.S. auditor must be registered with the PCAOB. The answer depends on whether the participating firm plays a “substantial role” defined in PCAOB rules. If that firm exceeds the threshold for a substantial role, it must register with the PCAOB.
The interpretive guidance also explains that, depending on the nature of the other firm’s participation in an audit, the lead firm has to comply with either PCAOB Auditing Standard (AS) 1201, Supervision of the Audit Engagement, or AS 1205, Part of the Audit Performed by Other Independent Auditors.”
In all circumstances, the firm should be mindful of compliance with other applicable PCAOB auditing standards and independence requirements, including with respect to the independence of the participating non-U.S. auditor,” the interpretive document says.
The power struggle between the Chinese government and the PCAOB is likely to continue. Paul Gillis, a professor of management at Peking University, posted in his “China Accounting Blog,” “The Q&A cynically sets up a requirement that no firm can comply with. The PCAOB needs to find a way to reach agreement with Chinese regulators to conduct inspections, discontinue the need for inspections, or deregister the firms it cannot inspect. Telling the firms that they will be punished if they do not break Chinese law in order to supply documents is not useful guidance.”
During her four-year term, Securities and Exchange Commission (SEC) Chair Mary Jo White expressed strong support for global accounting convergence. In January, she issued a 1,600-word statement calling for her successor under the Trump administration to continue to pursue efforts to more closely align U.S. Generally Accepted Accounting Principles (GAAP) with International Financial Reporting Standards (IFRS). Here’s an overview of the history of this project, along with White’s hopes for the future.
For the last 30 years, the SEC has batted around the issue of international accounting standards. Most of the countries in the world, including member states of the European Union, have adopted IFRS. And they’ve been increasingly pressuring U.S. accounting rulemakers to use global accounting standards.
But the SEC and Financial Accounting Standards Board have been hesitant to relinquish control over accounting rules and adopt a more principles-based regime under IFRS compared to existing U.S. GAAP. In 2012, SEC Chair Mary Schapiro authorized the publication of Release No. 33-9109, Commission Statement in Support of Convergence and Global Accounting Standards, which reviewed the SEC’s actions with regard to IFRS.
The publication highlighted numerous challenges the agency faced in adopting a rule that would expand the use of international reporting standards in the United States. A series of staff reports were released during the next two years that expanded on the statement and outlined some difficulties that would be encountered if U.S. companies were to use IFRS more extensively. Schapiro stepped down five months after the final report was issued and never made an IFRS rule a priority during her tenure.
When White took over the SEC reins in 2013, she expressed far more interest in IFRS than Schapiro had. In fact, White appointed James Schnurr, a strong advocate of global accounting convergence, as her chief accountant. Schnurr said several times during his 18-month tenure that he was working on an IFRS rule proposal, but the effort went nowhere.
In White’s recently issued statement, she said, “I remain firmly convinced of the importance for U.S. investors of high-quality, globally accepted accounting standards, and I believe that the commission must continue to pursue such standards as one of its highest priorities.”
Her statement called U.S. support of IFRS “imperative for the protection of U.S. investors and companies and the strength of our markets.” Just before leaving her post at the SEC in January, White encouraged the SEC to continue her past efforts on global accounting convergence. These efforts include a proposal that would let U.S. companies submit IFRS financial data as supplements to their regulatory filings with financial statements prepared in U.S. GAAP.
In July 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act, arguably the most comprehensive financial reform package since the Great Depression. The massive federal legislation included corporate governance measures for all public companies, compliance requirements for banks and financial institutions, and a host of other related changes, including enhanced consumer protections.
The Government Accountability Office (GAO), a congressional watchdog agency, recently issued a report that said the Dodd-Frank Act appeared to have shielded the financial markets from collapses of large banks or nonbank financial companies. The GAO said bank regulators, by requiring depository institutions to hold more equity capital and by strengthening their supervision of the swaps market, had made it less likely that a large institution would fail and trigger a marketwide panic. Moreover, the GAO concluded that large banks, while holding more assets on their balance sheet, had increased their equity capital by enough to withstand a financial shock.
The report also credited the rules requiring the posting of additional collateral for firms trading credit default swaps for the decrease in the amount of risk that trading firms are exposed to from the default of a major swaps market participant. (Such swaps are a hybrid of insurance and security.)
The future of Dodd-Frank Act reforms is uncertain under the Trump administration, however. During his campaign, President Trump pledged to repeal certain regulations made by the Obama administration. Many analysts expect an overall reduction in government regulations that burden businesses and compromise productivity, which could put Dodd-Frank protections on the chopping block in 2017 and beyond.
The practical effect of White’s statement is unclear, given that she largely gave up on the issue during her final year. As of this writing, the Trump administration’s views on IFRS have not been made public. Stay tuned for additional information in the coming months.