On October 28, 2021, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers.
In an effort to address the inconsistency and diversity in practice for the accounting of acquired revenue contracts with customers, the FASB is providing specific guidance that requires contract assets and contract liabilities acquired in a business combination to be recognized and measured in accordance with Topic 606, Revenue from Contracts with Customers.
The ASU is intended to improve comparability for both the recognition and measurement of acquired revenue contracts with customers at the date of and after a business combination.
When applying the acquisition method in Topic 805, an acquirer generally recognizes and measures identifiable assets acquired and liabilities assumed in a business combination at fair value.
While current Generally Accepted Accounting Principles (GAAP) provides guidance on how to measure assets and liabilities in a business combination, it doesn’t provide specific guidance for contract assets and liabilities arising from revenue contracts with customers or other similar contracts accounted for in accordance with Topic 606.
Under current guidance in Topic 805, an acquirer recognizes an assumed contract liability at fair value when the acquiree has received consideration up-front from the customer and there’s a remaining unsatisfied obligation as of the acquisition date.
Alternatively, when a contract is paid overtime as performance occurs, an acquirer doesn’t generally recognize a contract liability as there isn’t an identifiable asset or liability assumed as of the acquisition date.
While the timing of payment shouldn’t affect the amount of revenue recognized by an acquirer, in current practice, post-acquisition revenue will generally differ for a revenue contract that’s paid up-front prior to the acquisition when compared to a revenue contract that’s paid overtime after the acquisition.
To improve comparability and eliminate diversity in the accounting for acquired revenue contracts with customers in a business combination, the ASU provides guidance on how to recognize and measure those contract assets and liabilities in a business combination.
By adding an exception to the measurement principle under Topic 805 for contract assets and liabilities, an entity—or acquirer—is now required to recognize and measure contract assets and liabilities acquired in a business combination in accordance with Topic 606, rather than at fair value.
Recognition of an Acquired Contract Asset or Liability
An acquirer is required to account for the acquired revenue contract as if it had originated the contract. To achieve this, the acquirer will need to consider the terms of the contract and assess how the acquiree applied Topic 606.
At the acquisition date, the acquirer should use the definition of a performance obligation—as defined in Topic 606—to determine whether a contract asset or liability should be recognized.
In accordance with Topic 606, a contract asset should generally be recognized when future performance is required—or when promised goods or services have been transferred to the customer, but the acquiree hasn’t received payment and the acquiree’s right to consideration is conditioned on something other than the passage of time. And a contract liability should generally be recognized when there’s an unsatisfied performance obligation—or when the acquiree has been paid for goods or services promised in the contract but control hasn’t been transferred to the customer.
Applying Topic 606 to acquired revenue contracts will generally result in the acquirer recognizing a contract asset or liability consistent with how it was recognized and measured in the acquiree’s financial statements—as long as the acquiree prepared financial statements in accordance with GAAP.
Subsequent Revenue Recognized by Acquirer
To address the issue that the timing of payment for an acquired revenue contract affects the subsequent amount of revenue recognized by the acquirer, the ASU requires acquired contract assets and liabilities to be measured in accordance with Topic 606 at the acquisition date.
This means that an acquirer would no longer measure the remaining obligations of the acquired revenue contract at fair value, but instead would utilize the contract transaction price for the remaining performance obligations in accordance with Topic 606.
For purposes of allocating the transaction price, the ASU provides a practical expedient that allows the acquirer to determine the standalone selling price at the acquisition date, rather than as of the contract inception date.
Aligning the post-acquisition revenue recognized with the satisfaction of the performance obligations will result in a consistent approach to recognizing revenue that isn’t generally affected by the timing of payment.
The amended guidance applies to all entities that enter into a business combination within the scope of Subtopic 805-10 after the adoption of Topic 606.
The amendments don’t affect the accounting for other assets or liabilities that may arise from revenue contracts with customers in a business combination, such as:
- Customer-related intangible assets
- Contract-based intangible assets
For example, if an acquired revenue contract is considered to have terms that are either unfavorable or favorable relative to the market, the acquirer should still recognize a liability or asset for the off-market contract terms at the acquisition date.
For public business entities, the amendments are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years.
For all other entities, the amendments are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years.
Early adoption is permitted, including adoption in an interim period.
The amendments should be applied prospectively to business combinations occurring on or after the effective date.
If early adopted in an interim period, the amendments should be applied as follows:
- Retrospectively to business combinations that occurred on or after the beginning of the fiscal year that includes the interim period of early application
- Prospectively to business combinations that occur on or after the date of initial application
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