Changes to Definition of “Business” Benefit Real Estate Industry

Recently, the Financial Accounting Standards Board (FASB) issued an update that clarifies the definition of a business to help companies distinguish when a transaction should be accounted for as a business combination or simply as the sale or purchase of an asset or group of assets. This guidance comes as a response to concerns that the definition of a business was too broad and challenging to apply.

With this new change to Business Combinations Topic 805, the FASB’s revised definition of a business could reduce the number of transactions that are accounted for as business combinations.

The new FASB guidance

Under the new guidance, there is a test that helps determine when an integrated group of assets and activities is not a business. The test requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is combined in a single identifiable asset or a group of similar identifiable assets, the group is not a business. However, if the test fails, the changes in the new update require that, to be considered a business, a group must include an input and a substantive process that together contribute to create outputs and remove the evaluation of whether a market participant could replace missing elements.

According to the FASB, the new framework for determining when a set of assets and activities constitutes a business will provide more consistency, reduce the cost of compliance, and make the definition of a business more operable.

For public companies, the update is effective for annual periods beginning after Dec. 15, 2017, including interim periods within those periods. For all other companies and organizations, the update is effective for annual periods beginning after Dec. 15, 2018, and interim periods within annual periods beginning after Dec. 15, 2019. Early adoption is permitted and recommended, including for interim or annual periods in which the financial statements have not been issued or made available for issuance.

What does this mean for real estate?

This new definition update could especially benefit the real estate industry, likely resulting in more real estate acquisitions being accounted for as asset acquisitions rather than business combinations. According to Accounting Today, it is anticipated that most real estate will be considered an asset acquisition under the new guidance because land, buildings and related intangibles will be counted as a single asset or group of similar identifiable assets.

In order to determine which assets can be combined and considered a group, real estate entities should consider the nature of the assets first and the risks associated with managing and creating outputs from each asset to determine if they are similar.

If you purchase a performing real estate asset whether commercial, multi-family, industrial, etc., it could likely be accounted for as an asset purchase rather than a business combination moving forward. In most cases, this means you will simply need to allocate the purchase price to land and building using a reasonable basis, such as market comparisons, appraisers, etc. This could potentially mean no more valuation and allocation to intangible lease assets and liabilities, goodwill, or bargain purchases.

Contact me or another one of Kaufman Rossin’s assurance and advisory professionals with any questions about this new definition change and how it could affect your business.