Definition of a Business Essay
Definition of a Business
Fuzzy Dice, Inc. manufactures and distribute novelty items. Fuzzy is having a great demand on their products and are holding a large amount of cash on its balance sheet. In the same area are other manufacturing companies, among them Tiny Toys LLC, a children’s toy manufacturer. Tiny has been having financial troubles and recently filed for Chapter 11 bankruptcy protection. Fuzzy is interested in Tiny’s manufacturing facility, location and capabilities. Tiny’s manufacturing equipment is operational; they don’t have any goodwill, but have some intangible assets. Since, Fuzzy is holding so much cash they decided to buy Tiny’s and are in the final stages of the transaction. The Company is not certain in how to use Tiny’s facilities. They will either: a. continue to use the facility to manufacture toys or b. renovate the factory in order to expand their current operations.
Fuzzy is having trouble determining how they should record the transaction. There are three scenarios: -Operate the factory in its current capacity to manufacture toys. -Refurbish the factory to manufacture novelty items.
-Structure the acquisition through its French subsidiary, which issues stand-alone financial statements under IFRS. For each scenario they should determine if they would record the transaction as an acquisition of a business or acquisition of an asset.
Asset acquisition: The purchase of a company by buying its assets instead of its stock. An asset acquisition strategy may be used for a takeover or buyout if the target is bankrupt. Market knowledge, research and experience are important to a successful asset acquisition strategy. In some cases, a plan for selling the asset, called asset disposition, is built into the asset acquisition strategy. Bankruptcy proceedings represent an opportunity for a company to implement an asset acquisition strategy. By taking advantage of one company’s distressed position, another company can purchase assets like equipment and machinery for its own business at reduced prices. Business Combination: A transaction or other event in which an acquirer obtains control of one or more businesses. Transactions sometimes referred to as true mergers or mergers of equals also are business combinations. If a business combination occurs because of a bankruptcy reorganization or troubled debt restructuring under fresh start accounting, the purchase consideration should take into account the value of the restructured debt. In these cases the original book value of the debt will likely differ from its fair value.
Business (ASC 805): An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return. This definition is broad and can result in many transactions qualifying as business combinations when they are actually only asset acquisitions. When determining if a set of assets and activities is a business, the relevant factor is whether or not the integrated set is capable of being conducted and managed as a business and not if the seller operated the set as a business or if the acquirer intends to do so. Unless there is evidence to the contrary, any set of assets that includes goodwill is assumed to be a business. However, the existence of goodwill is not required to meet the definition of a business. If the acquired assets are not a business, the acquirer will account for the transaction as an asset acquisition. The definition goes on to explicitly discuss mergers of equals. A change of control can occur without the exchange of consideration or even without the acquirer holding any ownership interest. The acquisition date is defined as the date the acquirer obtains control of the acquiree, regardless of the legal date of the transfer or the date the consideration is transferred. If a business combination is affected primarily by transferring assets or by incurring liabilities, the acquirer is usually the entity that transfers the assets or incurs the liabilities.
If a business combination is affected by transferring equity interests, the acquirer is usually the entity that issues its equity interests. However, in some business combinations, commonly called reverse acquisitions, the issuing entity is the acquiree. In a reverse acquisition the legal acquirer is defined as the acquiree for accounting purposes. 55-4 A business consists of inputs and processes applied to those inputs that have the ability to create outputs. Although businesses usually have outputs, outputs are not required for an integrated set to qualify as a business. The three elements of a business are defined as follows: a. Input. Any economic resource that creates, or has the ability to create, outputs when one or more processes are applied to it. Examples include long-lived assets (including intangible assets or rights to use long-lived assets), intellectual property, the ability to obtain access to necessary materials or rights, and employees. b. Process. Any system, standard, protocol, convention, or rule that when applied to an input or inputs, creates or has the ability to create outputs.
Examples include strategic management processes, operational processes, and resource management processes. These processes typically are documented, but an organized workforce having the necessary skills and experience following rules and conventions may provide the necessary processes that are capable of being applied to inputs to create outputs. Accounting, billing, payroll, and other administrative systems typically are not processes used to create outputs. c. Output. The result of inputs and processes applied to those inputs that provide or have the ability to provide a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants.
Identifying a Business Combination
Classifying or Designating Identifiable Assets Acquired and Liabilities Assumed in a Business Combination 25-6 At the acquisition date, the acquirer shall classify or designate the identifiable assets acquired and liabilities assumed as necessary to subsequently apply other GAAP. The acquirer shall make those classifications or designations on the basis of the contractual terms, economic conditions, its operating or accounting policies, and other pertinent conditions as they exist at the acquisition date.
25-7 In some situations, GAAP provides for different accounting depending on how an entity classifies or designates a particular asset or liability. Examples of classifications or designations that the acquirer shall make on the basis of the pertinent conditions as they exist at the acquisition date include but are not limited to the following:
a. Classification of particular investments in securities as trading, available for sale, or held to maturity in accordance with Section 320-10-25
b. Designation of a derivative instrument as a hedging instrument in accordance with paragraph 815-10-05-4
c. Assessment of whether an embedded derivative should be separated from the host contract in accordance with Section 815-15-25 (which is a matter of classification as this Subtopic uses that term).
Identifiable Intangible Assets
25-10 The acquirer shall recognize separately from goodwill the identifiable intangible assets acquired in a business combination. An intangible asset is identifiable if it meets either the separability criterion or the contractual-legal criterion described in the definition of identifiable. Additional guidance on applying that definition is provided in paragraphs 805-20-25-14 through 25-15, 805-20-55-2 through 55-45, and Example 1 (see paragraph 805-20-55-52). For guidance on the recognition and subsequent measurement of a defensive intangible asset, see Subtopic 350-30.
05-4 Paragraph 805-10-25-1 requires that a business combination be accounted for by applying what is referred to as the acquisition method. The acquisition method requires all of the following steps:
a. Identifying the acquirer
b. Determining the acquisition date
c. Recognizing and measuring the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree
d. Recognizing and measuring goodwill or a gain from a bargain purchase. 805-10-25-1 An entity shall determine whether a transaction or other event is a business combination by applying the definition in this Subtopic, which requires that the assets acquired and liabilities assumed constitute a business. If the assets acquired are not a business, the reporting entity shall account for the transaction or other event as an asset acquisition. An entity shall account for each business combination by applying the acquisition method. Accounting After Acquisition
35-1 After the acquisition, the acquiring entity accounts for the asset or liability in accordance with the appropriate generally accepted accounting principles (GAAP). The basis for measuring the asset acquired or liability assumed has no effect on the subsequent accounting for the asset or liability.
25-1 As of the acquisition date, the acquirer shall recognize, separately from goodwill, the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. Recognition of identifiable assets acquired and liabilities assumed is subject to the conditions specified in paragraphs 805-20-25-2 through 25-3.
55-2 Paragraph 805-10-25-1 requires an entity to determine whether a transaction or event is a business combination. In a business combination, an acquirer might obtain control of an acquiree in a variety of ways, including any of the following: a. By transferring cash, cash equivalents, or other assets (including net assets that constitute a business) b. By incurring liabilities
c. By issuing equity interests
d. By providing more than one type of consideration
e. Without transferring consideration, including by contract alone (see paragraph 805-10-25-11). 55-3 A business combination may be structured in a variety of ways for legal, taxation, or other reasons, which include but are not limited to, the following: a. One or more businesses become subsidiaries of an acquirer or the net assets of one or more businesses are legally merged into the acquirer. b. One combining entity transfers its net assets or its owners transfer their equity interests to another combining entity or its owners. c. All of the combining entities transfer their net assets or the owners of those entities transfer their equity interests to a newly formed entity (sometimes referred to as a roll-up or put-together transaction). d. A group of former owners of one of the combining entities obtains control of the combined entity. 55-5 To be capable of being conducted and managed for the purposes defined, an integrated set of activities and assets requires two essential elements—inputs and processes applied to those inputs, which together are or will be used to create outputs.
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. FRS 3 Business Combinations outlines the accounting when an acquirer obtains control of a business (e.g. an acquisition or merger). Such business combinations are accounted for using the ‘acquisition method’, which generally requires assets acquired and liabilities assumed to be measured at their fair values at the acquisition date. Alternatives:
Fuzzy Inc should determine how they will account for the transaction with Tiny Toys if either as an acquisition of assets or as a business combination.
Using FASB’s ASC 805 definition of Business combination and acquisition of assets is hard to choose one alternative. The definitions are broad and can result in different interpretation on how to account for the transaction in the Balance Sheet, but I think the one that suits best the transaction is acquisition of assets. As guidance, I used ASC 805-05-4 Paragraph 805-10-25-1 that says: requires that a business combination be accounted for by applying what is referred to as the acquisition method. The acquisition method requires all of the following steps: a. Identifying the acquirer
b. Determining the acquisition date
c. Recognizing and measuring the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree d. Recognizing and measuring goodwill or a gain from a bargain purchase. 805-10-25-1 An entity shall determine whether a transaction or other event is a business combination by applying the definition in this Subtopic, which requires that the assets acquired and liabilities assumed constitute a business. If the assets acquired are not a business, the reporting entity shall account for the transaction or other event as an asset acquisition. In addition, manufacturing equipment and trucks are functional, but the case doesn’t mention anything about other type of assets necessary (e.g computers) for the operation of the business. This means that if Fuzz is in the intention of using the facilities as Business they will not be able to meet the three elements of a business: input, process, output. Fuzz probably is using the bankruptcy of Tiny as a strategy for acquiring needed assets and good stand geographical facility in a good price. Also, Fuzzy is not assuming any liability from Tiny.
Questions 2 and 3 will be answered by acquisition of assets, considering the information above. None of these two scenarios represent a business combination since neither of them can operate as a business. In case of question 1, is more difficult to determine how to account for it. Fuzz in the position to account for it in either one of the possibilities since the definitions presented are vague in structure and cannot be taken into account to conclude one straight answer. 1. If Fuzzy decides to operate the factory in its current capacity to manufacture children’s toys, should the transaction be accounted for under ASC 805 as an acquisition of a business or an acquisition of assets? 2. If Fuzzy decides to refurbish the factory to manufacture novelty items, would this affect its assessment of how to account for the transaction under ASC 805? 3. If Fuzzy decides instead to structure the acquisition through its French subsidiary, Dés Floue Inc., which issues stand-alone financial statements under IFRSs, should the transaction be accounted for differently under IFRSs with regard to whether it should be deemed as an acquisition of a business or a group of assets?