In October 2021, the FASB issued ASU 2021-08 on treatment for acquired contract assets and assumed contract liabilities for transactions within the scope of ASC 805, Business Combinations. The ASU significantly changes an acquirer’s measurement and recognition of acquired contract assets and assumed contract liabilities when compared to the legacy ASC 805 measurement and recognition model for such assets and liabilities.
Under the legacy ASC 805 guidance, the general measurement principle in ASC 805-20-30-1 explains that an acquirer must initially measure all assets acquired and liabilities assumed, with limited exceptions, at their acquisition date fair values in accordance with ASC 820, Fair Value Measurement. Accordingly, legacy U.S GAAP required contract assets and contract liabilities to be measured at fair value prior to the adoption of ASU 2021-08.
In contrast, ASU 2021-08 provides a recognition and measurement exception from fair value for contract assets and contract liabilities. As such, contract assets and contract liabilities are to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606, Revenue from Contracts with Customers, instead of being measured at the acquisition-date fair value. The new guidance may result in the acquirer recognizing contract assets and contract liabilities at the same amounts as recorded by the acquiree, contingent on certain qualifications, including an acquiree’s historical revenue recognition policies having been consistent with principles of ASC 606.
The potential benefits of adopting ASU 2021-08 include:
- The complexity and effort required in accounting for acquired customer contracts may be reduced.
- The acquirer will generally record more revenue in the post acquisition period.
- Consistent application of GAAP for acquired revenue contracts and arrangements, resulting in better comparability across periodic reporting.
- Less complexity in reporting and disclosing the impact of the acquisition to users of financial information and other stakeholders.
Our observation: While the adoption of ASU 2021-08 may significantly reduce complexity and effort required by the acquirer in accounting for acquired contract assets and assumed contract liabilities in certain transactions, the new standard may also add complexity and effort required by the acquirer. The complexity and effort required to determine the appropriate acquisition date contract asset and contract liability balances may be significant for private company acquisitions, especially if those companies have experienced significant growth in periods leading up to the acquisition, have limited documentation on formal revenue recognition policies, or have not been previously audited.
This summary discussion and the in-depth report examines the differences in the acquirer’s accounting models for acquired contact assets and assumed contract liabilities in a business combination between the legacy ASC 805 accounting framework and the updated accounting framework pursuant to ASU 2021-08.
1. Legacy accounting framework (prior to adoption of ASU 2021-08)
Under the legacy business combination guidance, contract assets and contract liabilities (i.e., deferred revenue) acquired in a business combination are recorded by the acquirer at fair value. An assumed obligation related to deferred revenue is measured at fair value at the date of acquisition, pursuant to the guidance in ASC 820. The requirement to measure deferred revenue based on an identification of legal obligations and at fair value typically results in a deferred revenue “haircut” resulting in the acquirer recording a lower deferred revenue balance than the acquiree’s preacquisition book value.
For instance, assume an acquiree had a deferred revenue balance of $100 for an arrangement where the customer had prepaid an annual subscription fee of $120. Assuming the underlying performance obligation is a stand-ready obligation that will be satisfied continuously during the 12-month term of the contract, the revenue for the related arrangement is recognized ratably over the 12-month subscription term under ASC 606. The acquiree is acquired with 10 months remaining in the contract term and the fair value of the deferred revenue balance is determined to be $50 at that time, representing a 50% reduction, or “haircut” from the acquiree’s preacquisition book value. In the post acquisition period, the acquirer would recognize $50 ratably over the remaining 10-month period, not the $100 which the acquiree would have recognized on a stand-alone basis prior to the acquisition, as a result of the requirement to measure contract liabilities at fair value under legacy ASC 805.
2. Updated accounting framework (after adoption of ASU 2021-08)
ASU 2021-08 provides an exception to the historical treatment of the general recognition and measurement principles under ASC 805 for contract assets and contract liabilities related to acquired customer contracts in a business combination. As such, acquired contract assets and assumed contract liabilities are not required to be measured at fair value after the adoption of the new standard. Instead, these will be measured and recognized pursuant to the principles of ASC 606.
The measurement of acquired contract assets and assumed contract liabilities under the ASU is premised on the notion that the accounting by the acquirer should be performed as if the acquirer had originated the contract with the customer. An acquirer may, however, assess and refer to an acquiree’s historical accounting for acquired customer contracts in determining the measurement and recognition of contract assets and contract liabilities. For instance, an acquiree would have recognized a contract liability for the remaining, unsatisfied performance obligations in accordance with ASC 606 when a revenue contract was paid fully upfront before an acquisition. This assessment by an acquirer may result in an acquirer recognizing contract assets and contract liabilities at the same amounts as historically recorded by an acquiree, and no further fair value assessment is needed under ASC 820.
For instance, assume an acquiree had a deferred revenue balance of $100 for an arrangement where the customer had prepaid an annual subscription fee of $120 and 10 months were remaining in the contract term. Assuming the underlying performance obligation is a stand-ready obligation that will be satisfied continuously during the 12-month term, the revenue for the related arrangement is recognized ratably over the 12-month subscription term under ASC 606. As part of the acquirer’s assessment of the acquiree’s historical accounting policies and practices, acquirer did not observe deviations from the principles of ASC 606, differences in estimates, or errors in acquiree’s historical application of ASC 606. Therefore, the acquirer would recognize a deferred revenue balance of $100 as part of the acquisition accounting. In the post acquisition period, the acquirer would recognize $100 ratably over the remaining 10-month period, which is same method of recognition for the $100 that the acquiree would have recognized prior to the acquisition.
In the basis of conclusions to ASU 2021-08, the FASB indicated that the differences between contract assets and contract liabilities recorded by an acquirer and those recorded by the acquiree before the acquisition generally would result from:
- Differences in the acquirer’s and acquiree’s revenue recognition accounting policies and the resulting change to the acquiree’s policies.
- Differences in estimates derived in applying the principles of ASC 606 between the acquirer and acquiree.
- Errors in the application of the principles of ASC 606 by the acquiree.
The ASU provides for two practical expedients for the acquirer’s measurement and recognition of acquired contract assets and assumed contract liabilities:
- The acquirer would apply ASC 606 for the acquiree’s revenue contracts that were modified during the pre-acquisition period using the latest modified terms of the contract as of the acquisition date to determine performance obligations and the transaction price.
- The acquirer is permitted to determine the standalone selling prices at the acquisition date, rather than at the contract inception date as otherwise required by ASC 606.
3. Scope and adoption dates
The ASU applies to contract assets and contract liabilities, as defined in ASC 606, from contracts with customers and other contracts to which the provisions of ASC 606 apply. The scope of the ASU excludes the following assets and liabilities relating to acquired customer contracts:
- Receivables under ASC 310, Receivables and ASC Subtopic 326-20, Financial Instruments—Credit Losses—Measured at Amortized Cost.
- Contract-based intangible assets and liabilities, such as customer relationships, backlogs, and contracts with off-market terms.
- Deferred costs in the scope of ASC Subtopic 340-40, Other Assets and Deferred Costs—Contracts with Customers.
- Other assets and liabilities that may be recognized under ASC 606. Examples of these may include refund liabilities or upfront payments to customers.
In the basis of conclusions to the ASU, the FASB further indicated that intangible assets associated with off-market terms in acquired customer contracts may also impact the subsequent revenue recognition by the acquirer even if intangible assets arising out of customer contracts are not directly within the scope of the ASU. In certain circumstances, an acquirer should recognize the amortization expense for such intangible assets as a reduction in revenue.
The effective dates and transition methods are as follows:
| Issuer Type | Effective date and Transition Methods |
|---|---|
| Public business entities (PBEs) | Fiscal years beginning after December 15, 2022, including interim periods within those fiscal years.
The amendments included in the new standard should be applied prospectively to business combinations occurring on or after the effective date of the new standard. Early adoption of the amendments is permitted, including adoption in an interim period. An entity that early adopts in an interim period should apply the amendments (1) retrospectively to all business combinations for which the acquisition date occurs on or after the beginning of the fiscal year that includes the interim period of early application and (2) prospectively to all business combinations that occur on or after the date of initial application. |
| Other entities | Fiscal years beginning after December 15, 2023, including interim periods within those fiscal years.
The transition methods for non-PBEs are the same transition methods for PBEs. |