Chapter 4 — Recognizing and Measuring the Identifiable Assets Acquired and Liabilities Assumed

4.3 Exceptions to Recognition, Measurement, and Designation or Classification of Assets or Liabilities

4.3.1 Exceptions to Recognition and Measurement

ASC 805-20

25-16 This Topic provides limited exceptions to the recognition and measurement principles applicable to business combinations. Paragraphs 805-20-25-17 through 25-28B specify the types of identifiable assets and liabilities that include items for which this Subtopic provides limited exceptions to the recognition principle in paragraph 805-20-25-1. The acquirer shall apply the specified GAAP or the specified requirements rather than that recognition principle to determine when to recognize the assets or liabilities identified in paragraphs 805-20-25-17 through 25-28B. That will result in some items being recognized either by applying recognition conditions in addition to those in paragraphs 805-20-25-2 through 25-3 or by applying the requirements of other GAAP, with results that differ from applying the recognition principle and conditions in paragraphs 805-20-25-1 through 25-3.

Pending Content (Transition Guidance: ASC 805-20-65-3)

25-16 This Topic provides limited exceptions to the recognition and measurement principles applicable to business combinations. Paragraphs 805-20-25-17 through 25-28C specify the types of identifiable assets and liabilities that include items for which this Subtopic provides limited exceptions to the recognition principle in paragraph 805-20-25-1. The acquirer shall apply the specified GAAP or the specified requirements rather than that recognition principle to determine when to recognize the assets or liabilities identified in paragraphs 805-20-25-17 through 25-28C. That will result in some items being recognized either by applying recognition conditions in addition to those in paragraphs 805-20-25-2 through 25-3 or by applying the requirements of other GAAP, with results that differ from applying the recognition principle and conditions in paragraphs 805-20-25-1 through 25-3.

25-17 Guidance is presented on all of the following exceptions to the recognition principle:

Assets and liabilities arising from contingencies
Income taxes
Employee benefits
Indemnification assets
Leases.

Pending Content (Transition Guidance: ASC 805-20-65-3)

25-17 Guidance is presented on all of the following exceptions to the recognition principle:

Assets and liabilities arising from contingencies
Income taxes
Employee benefits
Indemnification assets
Leases
Contract assets and contract liabilities.

30-12 Guidance is presented on all of the following exceptions to the measurement principle:

Income taxes
Employee benefits
Indemnification assets
Reacquired rights
Share-based payment awards
Assets held for sale
Certain assets and liabilities arising from contingencies
Leases
Purchased financial assets with credit deterioration.

Pending Content (Transition Guidance: ASC 805-20-65-3)

30-12 Guidance is presented on all of the following exceptions to the measurement principle:

Income taxes
Employee benefits
Indemnification assets
Reacquired rights
Share-based payment awards
Assets held for sale
Certain assets and liabilities arising from contingencies
Leases
Purchased financial assets with credit deterioration
Contract assets and contract liabilities.

As discussed above, ASC 805 includes several exceptions to fair value measurement and recognition. Because most assets acquired and liabilities assumed in an acquisition are subsequently accounted for under the relevant GAAP, the guidance provides exceptions to ensure that those subsequent applications of GAAP do not result in the recognition of a gain or loss when no such economic change occurred. For example, income taxes are an exception to the recognition and measurement principles and are accounted for under ASC 740. If that exception did not exist, an acquirer would be required to recognize and measure income taxes at fair value and the subsequent application of ASC 740 would result in the acquirer’s recognition of deferred taxes at amounts other than fair value or not at all. As a result, the acquirer would recognize a gain or loss even though no economic change had occurred.

4.3.2 Exceptions to Designation or Classification of Assets or Liabilities

ASC 805-20

25-8 This Section provides the following two exceptions to the principle in paragraph 805-20-25-6:

Classification of a lease of an acquiree shall be in accordance with the guidance in paragraph 842-10-55-11
Classification of a contract written by an entity that is in the scope of Subtopic 944-10 as an insurance or reinsurance contract or a deposit contract. The acquirer shall classify that contract on the basis of the contractual terms and other factors at the inception of the contract (or, if the terms of the contract have been modified in a manner that would change its classification, at the date of that modification, which might be the acquisition date).

ASC 805 requires most contracts, assets, and liabilities to be classified or designated on the acquisition date. However, there are two exceptions: lease agreements and insurance or reinsurance contracts. ASC 805-20-25-8 notes that if a contract has been modified in a manner that would change its classification, the acquirer should classify it on the basis of the contractual terms and other factors “at the date of that modification, which might be the acquisition date.” That is, if contracts are modified as a result of a business combination, an acquirer should take the modifications into account when classifying or designating the contracts, assets, or liabilities. However, some common changes to contracts do not affect the contracts’ terms. For example, as a result of a business combination, a lease agreement may be modified to change one of the parties to the contract. Such a change is not a substantive modification to the terms of the lease and would not affect its classification.

4.3.3 List of Exceptions to the Recognition, Measurement, Designation, or Classification of Assets or Liabilities

The table below lists the exceptions and highlights the sections in which they are discussed in this publication.

Recognition and measurement exceptions

Indemnification assets (see Section 4.3.4)
Assets held for sale (see Section 4.3.5)
Assets and liabilities arising from contingencies (see Section 4.3.6)
Reacquired rights (see Section 4.3.7)
Income taxes (see Section 4.3.8)
Employee benefits (see Section 4.3.9)
Purchased financial assets with credit deterioration (see Section 4.3.10)
Leases — after adoption of ASC 842 (see Section 4.3.11.1)
Leases — before adoption of ASC 842 (see Section 4.3.11.2)
Share-based payment awards (see Section 5.6)

Classification or designation exceptions

Leases — after adoption of ASC 842 (see Section 4.3.11.1)
Leases — before adoption of ASC 842 (see Section 4.3.11.2)
Insurance or reinsurance contracts (see Section 4.3.12)

4.3.4 Indemnification Assets

The seller in a business combination may contractually indemnify the acquirer for uncertainties related to specific assets or liabilities, such as those associated with lawsuits and uncertain tax positions. This type of indemnification represents an asset obtained in the business combination. Indemnification assets are an exception to the recognition and measurement principles.

Connecting the Dots

Amounts held in escrow pending resolution of general representation and warranty provisions contained in the acquisition agreement are not indemnification assets. See Section 5.3.1 for information about amounts held in escrow as part of an acquisition agreement.

4.3.4.1 Initial Accounting for Indemnification Assets

ASC 805-20

Indemnification Assets

25-27 The seller in a business combination may contractually indemnify the acquirer for the outcome of a contingency or uncertainty related to all or part of a specific asset or liability. For example, the seller may indemnify the acquirer against losses above a specified amount on a liability arising from a particular contingency; in other words, the seller will guarantee that the acquirer’s liability will not exceed a specified amount. As a result, the acquirer obtains an indemnification asset. The acquirer shall recognize an indemnification asset at the same time that it recognizes the indemnified item, measured on the same basis as the indemnified item, subject to the need for a valuation allowance for uncollectible amounts. Therefore, if the indemnification relates to an asset or a liability that is recognized at the acquisition date and measured at its acquisition-date fair value, the acquirer shall recognize the indemnification asset at the acquisition date measured at its acquisition-date fair value.

25-28 In some circumstances, the indemnification may relate to an asset or a liability that is an exception to the recognition or measurement principles. For example, an indemnification may relate to a contingency that is not recognized at the acquisition date because it does not satisfy the criteria for recognition in paragraphs 805-20-25-18A through 25-19 at that date. In those circumstances, the indemnification asset shall be recognized and measured using assumptions consistent with those used to measure the indemnified item, subject to management’s assessment of the collectibility of the indemnification asset and any contractual limitations on the indemnified amount.

30-18 Paragraph 805-20-25-27 requires that the acquirer recognize an indemnification asset at the same time that it recognizes the indemnified item, measured on the same basis as the indemnified item, subject to the need for a valuation allowance for uncollectible amounts. That paragraph also requires that, if the indemnification relates to an asset or a liability that is recognized at the acquisition date and measured at its acquisition-date fair value, the acquirer recognize the indemnification asset at the acquisition date measured at its acquisition-date fair value. For an indemnification asset measured at fair value, the effects of uncertainty about future cash flows because of collectibility considerations are included in the fair value measure and a separate valuation allowance is not necessary, as noted in paragraph 805-20-30-4.

30-19 Paragraph 805-20-25-28 states that in some circumstances, the indemnification may relate to an asset or a liability that is an exception to the recognition or measurement principles, and provides an example of an indemnification that may relate to a contingency that is not recognized at the acquisition date because it does not satisfy the criteria for recognition in paragraphs 805-20-25-18A through 25-19 at that date. Alternatively, an indemnification may relate to an asset or a liability, for example, one that results from an uncertain tax position that is measured on a basis other than acquisition-date fair value. (Paragraph 805-20-30-13 identifies the business-combination-related measurement requirements for income taxes.) Paragraph 805-20-25-28 establishes that in those circumstances, the indemnification asset shall be recognized and measured using assumptions consistent with those used to measure the indemnified item, subject to management’s assessment of the collectibility of the indemnification asset and any contractual limitations on the indemnified amount.

The recognition and measurement of an indemnification asset depends on whether the acquirer recognizes the indemnified item as part of the accounting for the business combination and how the acquirer measures the indemnified item. The following are examples of the recognition and measurement of certain types of indemnified items and the resulting indemnification assets:

Recognition and Measurement of the Indemnified Item	Recognition and Measurement of the Indemnification Asset
Recognized and measured at its acquisition-date fair value (e.g., a liability arising from a contingency recognized at its fair value as of the acquisition date).	Recognized and measured at its fair value as of the acquisition date, adjusted for any contractual limitations and the credit risk of the indemnifying party. Before adoption of ASU 2016-13, no separate valuation allowance is recognized related to collectibility for indemnification assets measured at fair value. We believe that after adoption of ASU 2016-13, if the indemnified item is a financial asset measured at amortized cost, the associated indemnification asset is within the scope of ASC 326-20 because ASC 805-20-25-27 requires the indemnification assets to be “measured on the same basis as the indemnified item, subject to the need for a valuation allowance for uncollectible amounts.” See Deloitte’s Roadmap Current Expected Credit Losses for more information.
Recognized as of the acquisition date but measured at an amount other than fair value (e.g., an uncertain tax position).	Recognized and measured by using assumptions that are consistent with those used to measure the indemnified item, adjusted for any contractual limitations and the credit risk of the indemnifying party. A separate valuation allowance is permitted for indemnification assets measured at other than fair value.
Unrecognized as of the acquisition date (e.g., a liability arising from a contingency that does not meet the criteria for recognition as of the acquisition date) and does not qualify for recognition during the measurement period.	Unrecognized as part of the business combination accounting. Subsequent accounting is based on applicable GAAP (see Section 4.3.4.2).
Recognized as of the acquisition date, but the indemnification only gives the acquirer the ability to recover a portion of the amount (e.g., the amount of recovery is limited to a specific amount or percentage).	Recognized and measured by using assumptions that are consistent with those used to measure the indemnified item, adjusted for the contractual limitations on recovery and the credit risk of the indemnifying party.

For indemnification assets recognized at fair value, no separate valuation allowance is recognized for concerns about collectibility before the adoption of ASU 2016-13. Entities should take into account collectibility concerns when measuring fair value since such concerns could result in a measurement of the indemnification asset that differs from that of the indemnified item. For indemnification assets measured at other than fair value, entities can establish a separate valuation allowance for collectibility concerns. Such an allowance would only affect presentation. We believe that after adoption of ASU 2016-13, if the indemnified item is a financial asset measured at amortized cost, the associated indemnification asset is within the scope of ASC 326-20 because ASC 805-20-25-27 requires indemnification assets to be “measured on the same basis as the indemnified item, subject to the need for a valuation allowance for uncollectible amounts.” See Deloitte’s Roadmap Current Expected Credit Losses for more information.

Example 4-1

Initial Recognition and Measurement of Indemnification Assets

On June 15, 20X9, Company A acquires Company B in a transaction accounted for as a business combination. In applying the acquisition method of accounting, A recognizes a $100 liability related to B’s uncertain tax position in accordance with ASC 740. As part of the acquisition, B’s former owners agree to indemnify A for any losses related to the tax position.

Under ASC 805, A should recognize an indemnification asset at the same amount as the liability, $100 (assuming collectibility is not in doubt). This amount most likely does not represent the asset’s fair value because ASC 740 does not require fair value measurement.

Acquisition agreements often include indemnification arrangements, but the parties to the business combination may instead establish such arrangements separately. In such cases, we believe that entities should consider analogizing to the factors in ASC 810-10-40-6 in determining whether to account for the acquisition agreement and the separate indemnification agreement as a single arrangement. Typically, we would expect that the application of those factors would lead an entity to conclude that the indemnification arrangement is part of the business combination agreement, in which case the acquirer would recognize, measure, and subsequently account for the indemnification assets by using the guidance in ASC 805.

4.3.4.2 Subsequent Accounting for Indemnification Assets

ASC 805-20

Indemnification Assets

35-4 At each subsequent reporting date, the acquirer shall measure an indemnification asset that was recognized in accordance with paragraphs 805-20-25-27 through 25-28 at the acquisition date on the same basis as the indemnified liability or asset, subject to any contractual limitations on its amount, except as noted in paragraph 805-20-35-4B, and, for an indemnification asset that is not subsequently measured at its fair value, management’s assessment of the collectibility of the indemnification asset.

40-3 The acquirer shall derecognize an indemnification asset recognized in accordance with paragraphs 805-20-25-27 through 25-28 only when it collects the asset, sells it, or otherwise loses the right to it.

When measuring an indemnification asset that was initially recognized as part of the accounting for a business combination, an entity should use assumptions that are consistent with those used to measure the indemnified item after the acquisition date, subject to any contractual limitations and considerations about the indemnifying party’s credit risk. If a change in the amount recognized for the indemnification asset is not the result of a qualifying measurement-period adjustment, the entity should recognize the change in earnings. An entity should use judgment in determining whether the changes to the indemnified item and the indemnification asset should be recognized in the same income statement line item so that they effectively offset one another.

Example 4-2

Subsequent Accounting for Indemnification Assets Recognized as of the Acquisition Date

Company A acquires Company B in a transaction accounted for as a business combination. As of the acquisition date, B has an open claim related to a contract dispute with a former supplier who is asserting damages of $100 million. In connection with the business combination, B’s selling shareholders agree to indemnify A for any losses related to this ongoing litigation up to $75 million. In applying the acquisition method of accounting, A recognizes and measures a $50 million liability for this ongoing litigation and an indemnification asset of $50 million because collectibility is not in doubt. After the measurement period for this item closes, a settlement is reached in the amount of $60 million.

Company A should increase its measurement of the liability to $60 million with a corresponding $10 million debit to the income statement. Also, if the additional amount due under the indemnification agreement is determined to be collectible, A should increase the indemnification asset to $60 million with a corresponding $10 million credit to the income statement.

If an indemnification asset only becomes recognizable after the measurement period for the indemnified item is closed, the recognition of the asset is subject to other GAAP rather than the guidance in ASC 805. In some cases, it may be appropriate to apply a loss recovery model to the recognition of the indemnification asset. The accounting framework underlying such a model is based on an analogy to the guidance on recognition of potential loss recoveries in ASC 410. Specifically, ASC 410-30-35-8, which provides subsequent measurement guidance related to environmental obligations, states, in part:

Potential recoveries may be claimed from a number of different parties or sources, including insurers, potentially responsible parties other than participating potentially responsible parties (see paragraph 410-30- 30-2), and governmental or third-party funds. The amount of an environmental remediation liability should be determined independently from any potential claim for recovery, and an asset relating to the recovery shall be recognized only when realization of the claim for recovery is deemed probable. The term probable is used in this Subtopic with the specific technical meaning in paragraph 450-20-25-1 [the future event or events are likely to occur].

The recognition criteria for a loss recovery is different from that for a gain contingency. Provided that its collection is probable, a loss recovery is recognized in the period in which the loss is incurred (or the period in which collection becomes probable). However, a gain contingency is recognized on the earlier of when the gain is realized or is realizable. While not codified, paragraph 16 of EITF Issue 01-10 provides the EITF’s understanding of the distinction between a loss recovery and a gain contingency: a loss recovery represents the recovery of a loss already recognized in the financial statements, whereas a gain contingency represents the recovery of a loss not yet recognized in the financial statements or recovery of an amount that is greater than the loss recognized in the financial statements.

Example 4-3

Subsequent Accounting for Indemnification Asset Not Recognized as of the Acquisition Date

On June 15, 20X9, Company A acquires Company B. Before the acquisition, B had ongoing litigation with a former supplier. In connection with the business combination, B’s selling shareholders agree to indemnify A for any losses related to that ongoing litigation. In applying the acquisition method, A concludes that a liability related to the ongoing litigation does not meet the criteria for recognition during the measurement period. Therefore, A does not recognize a liability or an indemnification asset related to the litigation. Eighteen months after the acquisition, A recognizes a liability for $100 million on the basis of a judgment reached in a similar case.

Company A should recognize an indemnification asset for $100 million under a loss recovery model (provided that collectibility of this amount from B’s selling shareholders is not in doubt) since recognition of the indemnification asset represents the recovery of a loss that is already recognized in the financial statements.

ASC 805-20-40-3 states that an acquirer only derecognizes an indemnification asset “when it collects the asset, sells it, or otherwise loses the right to it.” If there were no changes in the values of the recorded liability and associated indemnification asset after the acquisition date, both the asset and liability would be reversed upon derecognition, with no net effect on the income statement.

4.3.4.3 Subsequent Accounting for an Indemnification Asset Recognized as of the Acquisition Date After a Government-Assisted Acquisition of a Financial Institution

ASC 805-20

35-4B An indemnification asset recognized at the acquisition date in accordance with paragraphs 805-20-25-27 through 25-28 as a result of a government-assisted acquisition of a financial institution involving an indemnification agreement shall be subsequently measured on the same basis as the indemnified item. For example, if the expected cash flows on indemnified assets increase such that a previously recorded valuation allowance is reversed, an entity shall account for the associated decrease in the indemnification assets immediately in earnings.

4.3.5 Assets Held for Sale

ASC 805-20

Assets Held for Sale

30-22 The acquirer shall measure an acquired long-lived asset (or disposal group) that is classified as held for sale at the acquisition date in accordance with Subtopic 360-10, at fair value less cost to sell in accordance with paragraphs 360-10-35-38 and 360-10-35-43.

An entity may acquire a business with the intention of selling some of its long-lived assets shortly after the acquisition date. ASC 805-20-30-22 requires an acquirer to “measure an acquired long-lived asset (or disposal group) that is classified as held for sale at the acquisition date in accordance with Subtopic 360-10, at fair value less cost to sell in accordance with paragraphs 360-10-35-38 and 360-10-35-43.” Accordingly, a long-lived asset (or disposal group) that meets the criteria in ASC 360-10-45-12 for held-for-sale classification on the acquisition date is an exception to the measurement principle in ASC 805.

ASC 360-10-45-12 requires entities to classify a newly acquired long-lived asset or a disposal group as held for sale as of the acquisition date if it meets both of the following conditions:

“[I]f the one-year requirement in paragraph 360-10-45-9(d) is met (except as permitted by [paragraph 360-10-45-11]).”
“[A]ny other criteria in paragraph 360-10-45-9 that are not met [as of the acquisition] date are probable of being met within a short period following the acquisition (usually within three months).”

Accordingly, as specified in ASC 360-10-45-12, the acquirer must satisfy the one-year criterion in ASC 360-10-45-9(d) as of the acquisition date, but it can satisfy the other criteria in ASC 360-10-45-9 if they “are probable of being met within a short period following the acquisition (usually within three months).” If the long-lived asset or disposal group cannot be classified as held for sale, the assets and liabilities would be measured in accordance with the requirements in ASC 805, which would generally be fair value.

See Deloitte’s Roadmap Impairments and Disposals of Long-Lived Assets and Discontinued Operations for more information about the held-for-sale and discontinued-operations reporting criteria for a business or nonprofit activity that meets the held-for-sale classification criteria upon acquisition.

4.3.6 Assets and Liabilities Arising From Contingencies

ASC 805-20

25-18A The following recognition guidance in paragraphs 805-20-25-19 through 25-20B applies to assets and liabilities meeting both of the following conditions:

Assets acquired and liabilities assumed that would be within the scope of Topic 450 if not acquired or assumed in a business combination
Assets or liabilities arising from contingencies that are not otherwise subject to specific guidance in this Subtopic.

The ASC master glossary defines a contingency as “[a]n existing condition, situation, or set of circumstances involving uncertainty as to possible gain (gain contingency) or loss (loss contingency) to an entity that will ultimately be resolved when one or more future events occur or fail to occur.” Examples of contingencies include litigation, environmental liabilities, or warranty claims.

The guidance in ASC 805-20 on assets and liabilities arising from contingencies applies to assets and liabilities “that would be within the scope of Topic 450 if not acquired or assumed in a business combination” and are “not otherwise subject to specific guidance in this Subtopic [805-20].” For example, indemnification assets may meet the definition of a contingency; however, ASC 805-20 provides specific guidance on accounting for indemnification assets in a business combination. Similarly, income tax uncertainties or temporary differences, including loss carryforwards, are not contingencies because they are accounted for under ASC 740 rather than ASC 450 when they are outside of a business combination.

Contingencies that exist as of the acquisition date result from prior events or circumstances, which is why assets and liabilities arising from contingencies are often referred to as “preacquisition contingencies.” Outside of a business combination, contingencies are accounted for in accordance with the applicable GAAP (e.g., environmental liabilities); however, if no specific GAAP applies to them, they are accounted for as loss contingencies or gain contingencies under ASC 450. Loss contingencies are recognized if they are probable and reasonably estimable, whereas gain contingencies are recognized on the earlier of when they are realized or are realizable.

While contingencies acquired or assumed in a business combination result from past events, they may not have been recognized by the acquiree before the business combination because the recognition criteria are different for contingencies that arise outside of a business combination.

4.3.6.1 Initial Recognition and Measurement of Assets and Liabilities Arising From Contingencies

ASC 805-20

Acquisition Date Fair Value Determinable During Measurement Period

25-19 If the acquisition-date fair value of the asset or liability arising from a contingency can be determined during the measurement period, that asset or liability shall be recognized at the acquisition date. For example, the acquisition-date fair value of a warranty obligation often can be determined.

Acquisition Date Fair Value Not Determinable During Measurement Period

25-20 If the acquisition-date fair value of the asset or liability arising from a contingency cannot be determined during the measurement period, an asset or a liability shall be recognized at the acquisition date if both of the following criteria are met:

Information available before the end of the measurement period indicates that it is probable that an asset existed or that a liability had been incurred at the acquisition date. It is implicit in this condition that it must be probable at the acquisition date that one or more future events confirming the existence of the asset or liability will occur.
The amount of the asset or liability can be reasonably estimated.

25-20A The criteria in the preceding paragraph shall be applied using the guidance in Topic 450 for application of similar criteria in paragraph 450-20-25-2.

Recognition Criteria Not Met During Measurement Period

25-20B If the recognition criteria in paragraphs 805-20-25-19 through 25-20A are not met at the acquisition date using information that is available during the measurement period about facts and circumstances that existed as of the acquisition date, the acquirer shall not recognize an asset or liability as of the acquisition date. In periods after the acquisition date, the acquirer shall account for an asset or a liability arising from a contingency that does not meet the recognition criteria at the acquisition date in accordance with other applicable GAAP, including Topic 450, as appropriate.

Measurement of Assets and Liabilities Arising From Contingencies

30-9 Paragraphs 805-20-25-18A through 25-20B establish the requirements related to recognition of certain assets and liabilities arising from contingencies. Initial measurement of assets and liabilities meeting the recognition criteria in paragraph 805-20-25-19 shall be at acquisition-date fair value. Guidance on the initial measurement of other assets and liabilities from contingencies not meeting the recognition criteria of that paragraph, but meeting the criteria in paragraph 805-20-25-20 is at paragraph 805-20-30-23.

30-23 Initial measurement of assets and liabilities meeting the recognition criteria in paragraph 805-20-25-20 shall be at the amount that can be reasonably estimated by applying the guidance in Topic 450 for application of similar criteria in paragraph 450-20-25-2.

ASC 805 requires entities to perform two steps in determining whether an asset or liability arising from a contingency qualifies for recognition in a business combination. The first step is to evaluate whether the “fair value of the asset or liability arising from a contingency can be determined [at the acquisition date or] during the measurement period.” If so, the asset or liability is recognized as of its acquisition-date fair value as part of the accounting for the business combination.

Although ASC 805 does not provide specific guidance on whether the fair value of a contingency is determinable, it does state that “the acquisition-date fair value of a warranty obligation often can be determined.” However, in practice, the acquisition-date fair value of many contingencies, such as contingencies related to litigation, may not be determinable.

If an acquirer cannot determine the acquisition-date fair value of a contingency during the measurement period, it proceeds to the second step and recognizes the contingency at its estimated amount if (1) “it is probable that an asset existed or that a liability had been incurred at the acquisition date” and (2) “[t]he amount of the asset or liability can be reasonably estimated.” These requirements are similar to those in ASC 450 related to loss contingencies. However, in a business combination, both assets and liabilities arising from contingencies have the same recognition criteria, whereas under ASC 450 a gain contingency is not recognized until the earlier of when it is realized or it is realizable.

In some cases, an acquirer may not have identified the contingency either before or on the acquisition date. Although the contingency must have existed as of the acquisition date (i.e., it resulted from prior events), the acquirer is not limited to only recognizing items that were known at the time of acquisition. Contingencies identified during the measurement period that existed as of the acquisition date still qualify for recognition as part of the business combination accounting.

The fair value measurement of a contingent liability takes into account the time value of money. However, for contingent liabilities recognized at their estimated amounts, discounting is permitted, but not required, only if both the timing and amounts of future cash flows are fixed or reliably determinable on the basis of objective and verifiable information. Although ASC 410-30 specifically addresses environmental remediation liabilities, an entity may also find the guidance useful for evaluating whether discounting is appropriate for other contingencies arising from liabilities. ASC 410-30-35-12 states, in part, that the “measurement of the liability, or of a component of the liability, may be discounted to reflect the time value of money if the aggregate amount of the liability or component and the amount and timing of cash payments for the liability or component are fixed or reliably determinable.” However, because the timing and amounts of future cash flows of many contingencies are inherently subjective, it is often difficult for an entity to meet the criteria for discounting (e.g., in the early phases of litigation and environmental remediation efforts). In addition, if the timing and amounts of future cash flows are fixed or reliably determinable, the acquirer would likely be able to measure the contingency at fair value.

SEC Considerations

The Interpretative Response to Question 1 in SAB Topic 5.Y states that if a contingent liability is recognized on a discounted basis, the “notes to the financial statements should, at a minimum, include disclosures of the discount rate used, the expected aggregate undiscounted amount, expected payments for each of the five succeeding years and the aggregate amount thereafter, and a reconciliation of the expected aggregate undiscounted amount to amounts recognized in the statements of financial position.”

4.3.6.2 Subsequent Accounting for Contingencies Recognized as Part of the Business Combination

ASC 805-20

35-3 An acquirer shall develop a systematic and rational basis for subsequently measuring and accounting for assets and liabilities arising from contingencies depending on their nature.

ASC 805 does not provide specific subsequent measurement guidance for contingencies recognized in a business combination, except to say that “[a]n acquirer shall develop a systematic and rational basis for subsequently measuring and accounting for assets and liabilities arising from contingencies depending on their nature.” The subsequent accounting depends on whether the contingency was measured at fair value or at its estimated amount.

For contingencies initially recognized at fair value, the acquirer must develop a “systematic and rational” subsequent measurement approach that is consistent with the nature of the asset or liability. In paragraph B20 of the Basis for Conclusions of FSP FAS 141(R)-1, the FASB suggested that the methods used to subsequently account for guarantees initially recognized at fair value under ASC 460-10 (formerly FASB Interpretation 45) could be applied to warranty obligations initially recognized at fair value. We believe that the guidance in ASC 460-10 for the subsequent accounting of guarantees would also be an acceptable approach to accounting for other contingencies recognized at fair value, not just warranty obligations. Another systematic and rational approach would be for entities to subsequently account for contingencies by applying the methods used for AROs under ASC 410. Entities should use judgment in assessing whether the subsequent accounting method they select is consistent with the nature of the asset or liability. Entities should also apply the same method to similar assets and liabilities.

However, we do not believe that the application of ASC 450 to contingencies recognized at fair value would be a systematic or rational approach. This is because it would not be appropriate for an entity to recognize a contingency at fair value on the acquisition date and then immediately recognize a gain or loss upon measuring the contingency at its estimated amount under ASC 450. In addition, subsequently measuring a contingency at fair value is not a systematic or rational approach unless fair value measurement is required by other GAAP.

For contingencies initially recognized in accordance with ASC 805-20-30-23 at the amount that can be reasonably estimated, acquirers should apply other GAAP, including ASC 450, in periods after the acquisition date. However, assets arising from contingencies should not be derecognized after the acquisition date because they do not meet the gain contingency recognition threshold in ASC 450.

Adjustments to the amounts recognized for a contingency should be accounted for as measurement-period adjustments (see Section 6.1) if they are (1) made within the measurement period and (2) based on the facts and circumstances that existed as of the acquisition date. If the adjustments resulted from facts or circumstances that did not exist as of the acquisition date, they should be recognized in the income statement. It can be particularly challenging for entities to determine whether adjustments to contingencies result from changes in fact or are related to facts that existed as of the acquisition date, especially in the case of litigation-related contingencies.

If a contingency does not qualify for recognition as part of the accounting for a business combination, the acquirer should recognize the asset or liability when it meets the recognition criteria in the applicable GAAP, such as ASC 450 for contingencies or ASC 410 for loss recoveries (see discussion in Section 4.3.4.2 for more information). Under ASC 450, gain contingencies are not recognized until the earlier of when they are realized or are realizable. Because an acquirer cannot adjust the acquisition accounting for the recognition of a contingency after the end of the measurement period, contingencies that qualify for recognition outside of the business combination accounting are recognized in the income statement. Also, contingencies for which the obligating event did not exist on the acquisition date, even those that arose before the end of the measurement period, do not qualify as measurement-period adjustments since they are not related to facts and circumstances that existed as of the acquisition date.

Connecting the Dots

After a business combination, disputes may occur between an acquirer and the acquiree’s sellers, sometimes resulting in payments between the parties after the acquisition date. Alternatively, an acquirer’s shareholders may bring litigation against the acquirer for various reasons, such as a claim that the acquirer overpaid for the acquiree. Litigation arising from a business combination is not an asset or a liability arising from a contingency because it did not exist on or before the acquisition date. See Section 6.2.6 for information about disputes arising from the business combination.

For more information, see Deloitte’s Roadmap Contingencies, Loss Recoveries, and Guarantees.

4.3.7 Reacquired Rights

ASC 805-20-25-14 states that “[a]s part of a business combination, an acquirer may reacquire a right that it had previously granted to the acquiree to use one or more of the acquirer’s recognized or unrecognized assets. Examples of such rights include a right to use the acquirer’s trade name under a franchise agreement or a right to use the acquirer’s technology under a technology licensing agreement.” Such assets are called reacquired rights.

4.3.7.1 Initial Measurement of Reacquired Rights

ASC 805-20

Reacquired Rights

25-14 As part of a business combination, an acquirer may reacquire a right that it had previously granted to the acquiree to use one or more of the acquirer’s recognized or unrecognized assets. Examples of such rights include a right to use the acquirer’s trade name under a franchise agreement or a right to use the acquirer’s technology under a technology licensing agreement. A reacquired right is an identifiable intangible asset that the acquirer recognizes separately from goodwill. Paragraph 805-20-30-20 provides guidance on measuring a reacquired right, and paragraph 805-20-35-2 provides guidance on the subsequent accounting for a reacquired right.

25-15 If the terms of the contract giving rise to a reacquired right are favorable or unfavorable relative to the terms of current market transactions for the same or similar items, the acquirer shall recognize a settlement gain or loss. Paragraph 805-10-55-21 provides guidance for measuring that settlement gain or loss.

30-20 The acquirer shall measure the value of a reacquired right recognized as an intangible asset in accordance with paragraph 805-20-25-14 on the basis of the remaining contractual term of the related contract regardless of whether market participants would consider potential contractual renewals in determining its fair value.

A reacquired right is an identifiable intangible asset that an acquirer recognizes separately from goodwill because it arises from contractual rights. However, reacquired rights are an exception to ASC 805’s measurement principle because ASC 805 requires entities to measure them on the basis of the related contract’s remaining term, regardless of whether market participants would consider potential contract renewals in determining the rights’ fair value. While market participants would generally reflect expected renewals of the term of a contractual right in their fair value estimate of a right traded in the market, the FASB has observed that an acquirer that controls a reacquired right could assume indefinite renewals of its contractual term, effectively making the reacquired right an indefinite-lived intangible asset. The Board has therefore concluded that a right reacquired from an acquiree is no longer a contract with a third party and, in substance, has a finite life. Accordingly, reacquired rights are measured only on the basis of the remaining contractual term.

However, complexities can arise when a contract has no stated term or is perpetual. In making reacquired rights an exception to the measurement principle, the FASB intended to limit the value attributed to a reacquired right by restricting the measurement to only the remaining contractual term. In this way, an acquirer could not assume that there would be unlimited renewals (since the reacquired right becomes a contract between the acquirer and itself as a result of the acquisition), classify the reacquired right as indefinite-lived, and measure it consistently with its classification. Accordingly, we would expect it to be unusual for a reacquired right to be classified as indefinite-lived. Before classifying a reacquired right as indefinite-lived and measuring it consistently with its classification, entities should consider consulting with experts, and SEC registrants should consider consulting with the SEC staff on a prefiling basis.

At the 2005 AICPA Conference on Current SEC and PCAOB Developments, then SEC OCA Professional Accounting Fellow Brian Roberson stated the following regarding the valuation of reacquired rights:

[R]egarding valuation, you need to value the right as if you were buying a right that you did not previously own. A problem is that the rights are oftentimes not transacted on a standalone basis after the initial sale. For example, a restaurant franchise is granted and the franchisee develops a business using the trade name granted by the franchise agreement. Upon reacquisition, the franchisor typically purchases the entire business, which is now an operating restaurant. On the surface, it seems intuitive that a mature franchise right such as in this example would be worth more than a new franchise right, but you have to think about what is driving that value. The restaurant’s value may be driven by other assets, such as customer relationship intangibles from catering contracts, appreciated real estate, and a strong workforce, which is a component of goodwill.

While a reacquired right is the result of a preexisting contractual relationship with the acquiree, not all preexisting relationships with an acquiree will result in the recognition of a reacquired right because not all preexisting relationships (e.g., a lawsuit) lead to the reacquisition of a right previously granted to the acquiree. If the terms of the preexisting contractual relationship giving rise to a reacquired right are favorable or unfavorable relative to the terms of current market transactions for the same or similar items, the acquirer must recognize a settlement gain or loss related to the preexisting contractual relationship separately from the accounting for the business combination. ASC 805-10-55-21 provides guidance on measuring that settlement gain or loss (see Section 6.2.2 for more information).

4.3.7.2 Subsequent Accounting for Reacquired Rights

ASC 805-20

35-2 A reacquired right recognized as an intangible asset in accordance with paragraph 805-20-25-14 shall be amortized over the remaining contractual period of the contract in which the right was granted. An acquirer that subsequently sells a reacquired right to a third party shall include the carrying amount of the intangible asset in determining the gain or loss on the sale.

ASC 805-20-35-2 states that an entity amortizes a reacquired right “over the remaining contractual period of the contract in which the right was granted.” If an acquirer subsequently sells a reacquired right to a third party, the carrying amount of the intangible asset is included in the determination of the gain or loss on the sale. If the acquirer subsequently sells only a portion of the reacquired right to the third party, the acquirer will need to develop a reasonable allocation method for measuring the portion of the intangible asset’s carrying amount that it will include in determining the gain or loss on the sale. Such an allocation method would be necessary if, for example, an acquirer reacquires a franchise right to a specific geographic area and then subsequently subdivides that geographic area and sells only a portion of it to a third party.

4.3.8 Income Taxes

ASC 805-20

25-21 Section 805-740-25 establishes the recognition guidance for accounting for income taxes in a business combination.

30-13 Section 805-740-30 establishes the measurement guidance related to accounting for income taxes in a business combination.

Income taxes are an exception to the recognition and measurement principles in ASC 805. For information about accounting for income taxes in a business combination, see Deloitte’s Roadmap Income Taxes.

4.3.9 Employee Benefits

ASC 805-20

25-22 The acquirer shall recognize a liability (or asset, if any) related to the acquiree’s employee benefit arrangements in accordance with other GAAP. For example, employee benefits in the scope of the guidance identified in paragraphs 805-20-25-23 through 25-26 would be recognized in accordance with that guidance and as specified in those paragraphs.

Pension and Postretirement Benefits Other Than Pensions

25-23 Guidance on defined benefit pension plans is presented in Subtopic 715-30. If an acquiree sponsors a single-employer defined benefit pension plan, the acquirer shall recognize as part of the business combination an asset or a liability representing the funded status of the plan (see paragraph 715-30-25-1). Paragraph 805-20-30-15 provides guidance on determining that funded status. If an acquiree participates in a multiemployer plan, and it is probable as of the acquisition date that the acquirer will withdraw from that plan, the acquirer shall recognize as part of the business combination a withdrawal liability in accordance with Subtopic 450-20.

25-24 The Settlements, Curtailments, and Certain Termination Benefits Subsections of Sections 715-30-25 and 715-30-35 establish the recognition guidance related to accounting for settlements and curtailments of defined benefit pension plans and certain termination benefits.

25-25 Guidance on defined benefit other postretirement plans is presented in Subtopic 715-60. If an acquiree sponsors a single-employer defined benefit postretirement plan, the acquirer shall recognize as part of the business combination an asset or a liability representing the funded status of the plan (see paragraph 715-60-25-1). Paragraph 805-20-30-15 provides guidance on determining that funded status. If an acquiree participates in a multiemployer plan and it is probable as of the acquisition date that the acquirer will withdraw from that plan, the acquirer shall recognize as part of the business combination a withdrawal liability in accordance with Subtopic 450-20.

Other Employee Benefit Arrangements

25-26 See also the recognition-related guidance for the following other employee benefit arrangements:

One-time termination benefits in connection with exit or disposal activities. See Section 420-10-25.
Compensated absences. See Section 710-10-25.
Deferred compensation contracts. See Section 710-10-25.
Nonretirement postemployment benefits. See Section 712-10-25.

30-14 The acquirer shall measure a liability (or asset, if any) related to the acquiree’s employee benefit arrangements in accordance with other GAAP. For example, employee benefits in the scope of the guidance identified in paragraphs 805-20-30-15 through 30-17 would be measured in accordance with that guidance and as specified in those paragraphs.

Pension and Postretirement Benefits Other Than Pensions

30-15 Guidance on defined benefit pension plans is presented in Subtopic 715-30. Guidance on defined benefit other postretirement plans is presented in Subtopic 715-60. Paragraphs 805-20-25-23 and 805-20-25-25 require an acquirer to recognize as part of a business combination an asset or a liability representing the funded status of a single-employer defined benefit pension or postretirement plan. In determining that funded status, the acquirer shall exclude the effects of expected plan amendments, terminations, or curtailments that at the acquisition date it has no obligation to make. The projected benefit obligation assumed shall reflect any other necessary changes in assumptions based on the acquirer’s assessment of relevant future events.

30-16 The Settlements, Curtailments, and Certain Termination Benefits Subsection of Section 715-30-35 establishes the measurement guidance related to accounting for settlements and curtailments of defined benefit pension plans and certain termination benefits.

Other Employee Benefit Arrangements

30-17 See also measurement-related guidance for the following other employee benefit arrangements:

One-time termination benefits in connection with exit or disposal activities. See Section 420-10-30.
Compensated absences. See Section 710-10-25.
Deferred compensation contracts. See Section 710-10-30.
Nonretirement postemployment benefits. See Section 712-10-25.

Contractual Termination Benefits and Curtailment Losses

55-50 An entity that has agreed to a business combination may develop a plan to terminate certain employees. The plan will be implemented only if the combination is consummated, but the entity assesses the likelihood of the combination to be probable. In this circumstance, when terminated, the employees will be entitled to termination benefits under a preexisting plan or contractual relationship. The termination of the employees also may affect the entity’s assumptions in estimating its obligations for pension benefits, other postretirement benefits, and postemployment benefits; that is, the termination of the employees may trigger curtailment losses or the recording of a contractual termination benefit.

55-51 The liability for the contractual termination benefits and the curtailment losses under employee benefit plans that will be triggered by the consummation of the business combination shall not be recognized when it is probable that the business combination will be consummated; rather it shall be recognized when the business combination is consummated.

Employee benefit arrangements that are within the scope of ASC 710, ASC 712, and ASC 715 are exceptions to ASC 805’s recognition and measurement principles. The FASB established this broad exception to avoid having to reconsider the requirements under multiple standards, which would have been outside the scope of the business combinations project. ASC 805-20-25-22 requires an acquirer to “recognize [and measure] a liability (or asset, if any) related to the acquiree’s employee benefit arrangements in accordance with other GAAP.” ASC 805-20-25-23 through 25-26 also note that the following standards provide recognition and measurement guidance on employee benefits:

Deferred compensation contracts — see ASC 710-10-25.
Compensated absences — see ASC 710-10-25.
Defined benefit pension plans — see ASC 715-30.
Settlements, curtailments, and certain termination benefits — see ASC 715-30-25 and ASC 715-30-35.
Other postretirement plans — see ASC 715-60.
Multiemployer plans for which “it is probable as of the acquisition date that the acquirer will withdraw from that plan” — see ASC 450-20.
Nonretirement postemployment benefits — see ASC 712-10-25.
One-time termination benefits related to exit or disposal activities — see ASC 420-10-25.

4.3.9.1 Pension and Other Postretirement Benefit Plans

If an acquirer will assume as part of a business combination a single-employer defined benefit plan (including a defined benefit pension plan or postretirement benefit plan) sponsored by the acquiree, the acquirer should recognize an asset or a liability on the acquisition date for the funded status of the plan. If, as of the acquisition date, the fair value of the plan assets exceeds the projected benefit obligation, an asset is recognized; however, if the projected benefit obligation exceeds the fair value of the plan assets, a liability is recognized. Previously unrecognized prior service costs, gains or losses, and transition amounts of the acquiree related to the assumed plan, including amounts previously recognized in other comprehensive income, are not carried forward.

Under ASC 805-20-30-15, when measuring the funded status of pension and other postretirement plans, an acquirer must exclude the effects of an entity’s planned but not executed amendments, terminations, and curtailments. Planned or expected amendments, terminations, and curtailments are not considered part of the liability assumed on the acquisition date. Such actions are recognized in the postcombination financial statements in accordance with ASC 715.

Upon an acquisition or a change in control, an acquirer may be obligated to modify an existing plan. The acquirer should assess the modification to determine whether it is part of the business combination or whether it should be accounted for outside of the business combination in accordance with ASC 805-10-55-18. If the modification is determined to be part of the business combination, the acquirer should include the effect of the modification on the existing plan in measuring the plan’s funded status.

The measurement of the projected benefit obligation for pensions or accumulated postretirement benefit obligation for other postretirement benefits and the fair value of the plan assets on the acquisition date should reflect any other necessary changes in discount rates or other assumptions that are based on the acquirer’s assessment of relevant future events.

In addition, ASC 805-20-55-51 addresses the accounting for contractual termination benefits and curtailment losses in an acquiree’s preacquisition financial statements. It states that “[t]he liability for the contractual termination benefits and the curtailment losses under employee benefit plans that will be triggered by the consummation of the business combination shall not be recognized when it is probable that the business combination will be consummated; rather it shall be recognized when the business combination is consummated.”

Example 4-4

Anticipated Plan Amendments in Connection With a Business Combination

Company A intends to acquire Company B in a business combination. Company B currently offers pension benefits to its employees, and as part of the acquisition agreement, A agrees to offer competitive pension benefits to B’s employees for one year after the transaction. Company A is evaluating the possibility of reducing these benefits after one year; but as of the acquisition date, it has not decided how or to what extent the benefits will change. Any change most likely would result in a reduction in the liability representing the plan’s funded status.

ASC 805-20-30-15 states that in “determining that funded status, the acquirer shall exclude the effects of expected plan amendments . . . that at the acquisition date it has no obligation to make.” Because A has no obligation as of the acquisition date to recognize the effects of an expected, but voluntary, amendment, it should not recognize the effect of its expected modification as part of the business combination accounting. If A decides to change B’s employees’ pension benefits after the acquisition date, these changes should be treated as plan amendments in accordance with ASC 715-30-35-10 through 35-17.

Example 4-5

Anticipated Changes to OPEB Plan in Connection With a Business Combination

Company A is acquiring Company B, which currently sponsors an other postemployment benefits (OPEB) plan. The assumptions that B uses to measure the funded status of its plan (e.g., the method to determine the discount rate) differ from those used by A. In addition, certain provisions of B’s plan are different from those of A. After the business combination, A intends to amend B’s plan to make it consistent with its own plans; however, A has no obligation to make amendments on the acquisition date.

ASC 805-20-30-15 states that “the acquirer shall exclude the effects of expected plan amendments, terminations, or curtailments that at the acquisition date it has no obligation to make.” However, in accordance with ASC 805-20-30-15, the plan liabilities that A assumes should “reflect any other necessary changes in assumptions based on the acquirer’s assessment of relevant future events.” That is, to measure B’s plan liabilities, A may use assumptions that are consistent with those used in the measurement of its existing plans, including, for example, the discount rates, health care cost inflation, Medicare reimbursement rates, and expected return on plan assets.

4.3.9.2 Postemployment Benefits

ASC 712 applies to all types of postemployment benefits other than pensions, postretirement benefits, deferred compensation arrangements, and termination benefits, which are addressed in other standards. ASC 712-10-25-5 requires an entity to account for a liability for postemployment benefits in accordance with ASC 450 if those benefits within the scope of ASC 712 do not meet the conditions in ASC 710-10-25-1. In addition, the Background Information and Basis for Conclusions of FASB Statement 112 states that an entity may refer to the guidance in FASB Statement 87 (ASC 715-30) and FASB Statement 106 (ASC 715-60) on measuring a liability for postemployment benefit obligations. While not codified, the guidance in Statement 112’s Background Information and Basis for Conclusions continues to be relevant. Thus, in a manner consistent with the treatment of pensions and OPEBs (see Section 4.3.9.1), an acquirer must exclude the effects of any planned amendments, terminations, or curtailments from the measurement of the assumed obligation in a business combination unless such information is required as part of the acquisition agreement or as a result of the change in control. Measurement of the assumed obligation should reflect any other necessary changes in discount rates or other assumptions based on the acquirer’s assessment of the relevant future event.

4.3.9.3 Multiemployer Plans

Multiemployer plans are accounted for differently than single employer plans, as discussed in ASC 715-80. Liabilities for multiemployer plans generally are recognized only for unpaid contributions as of the acquisition date. ASC 805-20-25-23 states that an acquirer recognizes a withdrawal liability as of the acquisition date in accordance with ASC 450-20 if it is probable that, as of that date, the acquirer will withdraw from a multiemployer plan.

4.3.10 Purchased Financial Assets — After Adoption of ASU 2016-13

ASC 805-20

30-4A For acquired financial assets that are not purchased financial assets with credit deterioration, the acquirer shall record the purchased financial assets at the acquisition-date fair value. Additionally, for these financial assets within the scope of Topic 326, an allowance shall be recorded with a corresponding charge to credit loss expense as of the reporting date.

30-4B For assets accounted for as purchased financial assets with credit deterioration (which includes beneficial interests that meet the criteria in paragraph 325-40-30-1A), an acquirer shall recognize an allowance in accordance with Topic 326 with a corresponding increase to the amortized cost basis of the financial asset(s) as of the acquisition date.

30-26 An acquirer shall recognize purchased financial assets with credit deterioration (including beneficial interests meeting the conditions in paragraph 325-40-30-1A) in accordance with Section 326-20-30 for financial instruments measured at amortized cost or Section 326-30-30 for available-for-sale debt securities. Paragraphs 326-20-55-57 through 55-78 illustrate how the guidance is applied for purchased financial assets with credit deterioration measured at amortized cost. Paragraphs 326-30-55-5 through 55-7 illustrate how the guidance is applied to available-for-sale debt securities. An acquirer shall not accrete into interest income the credit losses embedded in the purchase price for purchased financial assets with credit deterioration.

In June 2016, the FASB issued ASU 2016-13, which not only provides a model for recognizing credit losses on financial assets held at amortized cost and available-for-sale (AFS) debt securities but also amends ASC 805 to provide guidance on accounting for purchased financial assets in a business combination. After an entity adopts ASU 2016-13, the accounting for acquired financial assets within the scope of ASC 326 will depend on whether the assets have experienced more-than-insignificant deterioration in credit quality since origination. Before adoption of ASU 2016-13, an acquirer is not permitted to recognize a valuation allowance as of the acquisition date for assets acquired in a business combination that are initially recognized at fair value (see Section 4.5 for more information).

As noted in ASC 805-20-30-4A, “[f]or acquired financial assets that are not purchased financial assets with credit deterioration, the acquirer shall record the purchased financial assets at the acquisition-date fair value. Additionally, for these financial assets within the scope of Topic 326, an allowance shall be recorded with a corresponding charge to credit loss expense as of the reporting date.”

However, ASC 805-20-30-4B states that “[f]or assets accounted for as purchased financial assets with credit deterioration (which includes beneficial interests that meet the criteria in paragraph 325-40-30-1A), an acquirer shall recognize an allowance in accordance with Topic 326 with a corresponding increase to the amortized cost basis of the financial asset(s) as of the acquisition date.” The ASC master glossary, as amended by ASU 2016-13, defines purchased financial assets with credit deterioration as:

Acquired individual financial assets (or acquired groups of financial assets with similar risk characteristics) that as of the date of acquisition have experienced a more-than-insignificant deterioration in credit quality since origination, as determined by an acquirer’s assessment.

As a result, upon acquiring a PCD asset, an entity that has adopted ASU 2016-13 would recognize an allowance for expected credit losses as an adjustment that increases the asset’s cost basis (the “gross-up” approach). That is, an acquirer initially measures the amortized cost of a PCD asset by (1) determining the acquisition-date estimate of expected credit losses under the applicable impairment model (e.g., ASC 326-20-30 for financial instruments measured at amortized cost or ASC 326-30-30 for AFS debt securities) and (2) adding that amount to the asset’s fair value. No credit loss expense is recognized upon acquisition since an allowance for expected credit losses is recognized separately from the PCD asset to establish its amortized cost on the acquisition date. In addition, ASC 326-20-30-13 clarifies that “[a]ny noncredit discount or premium resulting from acquiring a pool of purchased financial assets with credit deterioration shall be allocated to each individual asset. At the acquisition date, the initial allowance for credit losses determined on a collective basis shall be allocated to individual assets to appropriately allocate any noncredit discount or premium.”

Example 12 in ASC 326-20 illustrates how an entity applies the PCD model, specifically the gross-up approach to recognizing expected credit losses as an adjustment to the amortized cost basis of the acquired assets.

After initial recognition of the PCD asset and its related allowance, the entity continues to apply the current expected credit losses model to the asset — that is, any changes in the estimate of cash flows that the entity expects to collect (favorable or unfavorable) are recognized immediately as credit loss expense in the income statement. Interest income recognition is based on the purchase price plus the initial allowance accreting to the contractual cash flows.

Changing Lanes

In June 2023, the FASB issued a proposed ASU that would amend the guidance in ASU 2016-13 regarding the accounting upon the acquisition of financial assets acquired in (1) a business combination, (2) an asset acquisition, or (3) the consolidation of a VIE that is not a business. The proposed ASU would broaden the population of financial assets that are within the scope of the gross-up approach under ASC 326 by requiring an acquirer to apply the gross-up approach in accordance with ASC 805 to all financial assets acquired in a business combination rather than only to PCD assets. Practitioners should monitor the proposed ASU for any developments that might change the current accounting. See additional discussion regarding the impact of the proposed ASU on the accounting for asset acquisitions in Section C.3.7.

See Deloitte’s Roadmap Current Expected Credit Losses for more information.

4.3.11 Leases

In February 2016, the FASB issued ASU 2016-02, which amends the Board’s guidance on the accounting for leases. The ASU added to U.S. GAAP ASC 842, which, when effective for all entities, will supersede the existing leasing guidance in ASC 840. The sections below address the accounting for leases acquired in a business combination both after and before adoption of ASC 842.

4.3.11.1 Leases — After Adoption of ASC 842

Leases (including contracts that contain a lease) acquired in a business combination may result in the recognition of various assets or liabilities, depending on the classification of the lease and whether the acquiree is the lessee or the lessor under the lease contract. The subsections that follow describe the accounting for leases acquired in a business combination after the adoption of ASC 842.

For additional information on the issues discussed in this section, see Deloitte’s Roadmap Leases.

4.3.11.1.1 Classification

ASC 805-20

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.

25-8 This Section provides the following two exceptions to the principle in paragraph 805-20-25-6:

Classification of a lease of an acquiree shall be in accordance with the guidance in paragraph 842-10-55-11 . . . .

ASC 842-10

55-11 In a business combination or an acquisition by a not-for-profit entity, the acquiring entity should retain the previous lease classification in accordance with this Subtopic unless there is a lease modification and that modification is not accounted for as a separate contract in accordance with paragraph 842-10-25-8.

As indicated in ASC 842-10-55-11, an acquirer in a business combination should retain the acquiree’s classification of its leases unless “there is a lease modification and that modification is not accounted for as a separate contract.”

The ASC master glossary defines a lease modification as:

A change to the terms and conditions of a contract that results in a change in the scope of or the consideration for a lease (for example, a change to the terms and conditions of the contract that adds or terminates the right to use one or more underlying assets or extends or shortens the contractual lease term). [Emphasis added]

As part of a business combination, a lease might also be changed in ways that do not qualify as a lease modification. For example, a lease may be changed to reflect the new owner of the acquiree. Such a change in the name of one of the parties identified in the contract would not qualify as a lease modification without a change in the scope of or consideration for the lease.

If the terms of a lease are modified as part of a business combination such that there is a lease modification, the acquirer should use the guidance in ASC 842 to determine whether to account for that modification as a separate contract. ASC 842-10-25-8 states that a lease modification should be considered a separate contract (i.e., “separate from the original contract”) if both of the following conditions exist:

The modification grants the lessee an additional right of use not included in the original lease (for example, the right to use an additional asset).
The lease payments increase commensurate with the standalone price for the additional right of use, adjusted for the circumstances of the particular contract. For example, the standalone price for the lease of one floor of an office building in which the lessee already leases other floors in that building may be different from the standalone price of a similar floor in a different office building, because it was not necessary for a lessor to incur costs that it would have incurred for a new lessee.

Therefore, a lease modification that meets the conditions in ASC 842-10-25-8 effectively results in two separate contracts: (1) the original unmodified contract and (2) a separate contract for the additional right of use. Accordingly, if the lease modification is considered a separate contract, the classification of the original lease is not reconsidered as part of the business combination and the additional right of use added in the lease modification is accounted for, and classified as, a separate “new” lease in accordance with ASC 842 when that lease commences.

However, if the modification does not meet the conditions to be accounted for as a separate contract, the acquirer reconsiders the classification of the lease on the basis of modified terms and conditions that exist as of the acquisition date (i.e., the effective date of the modification) in accordance with ASC 842-10-25-9 and ASC 842-10-25-11 through 25-18.

The flowchart below summarizes the process for classifying an acquiree’s lease contracts.

4.3.11.1.2 Potential Assets or Liabilities Arising From an Acquiree’s Lease

ASC 805-20

Leases

25-28A The acquirer shall recognize assets and liabilities arising from leases of an acquiree in accordance with Topic 842 on leases (taking into account the requirements in paragraph 805-20-25-8(a)).

Right-of-use (ROU) assets and lease liabilities arising from an acquiree’s operating or finance leases are exceptions to ASC 805’s recognition and fair value measurement principles. Instead, ROU assets and lease liabilities are recognized and measured in accordance with ASC 842. However, an acquirer should recognize and measure at fair value certain lease-related intangible assets or liabilities previously recognized by the acquiree (e.g., in-place lease intangible assets).

The table below lists the potential assets or liabilities that may be recognized in connection with an acquiree’s leases. Each item is discussed in more detail in the sections noted.

Lease Type	Asset or Liability That May Be Recognized
Acquiree is the lessee in an operating or finance lease	ROU asset (see Section 4.3.11.1.3) Lease liability (see Section 4.3.11.1.3) Leasehold improvements owned by the acquiree (see Section 4.3.11.1.9) Intangible asset for an in-place lease (see Section 4.3.11.1.10)
Acquiree is the lessee, and the remaining lease term is 12 months or less	Accounting policy election to not recognize assets or liabilities for short-term leases, including intangible assets or liabilities for off-market terms or in-place leases (see Section 4.3.11.1.4)
Acquiree is the lessor in an operating lease	Asset (i.e., the property, plant, or equipment) subject to the lease (see Section 4.3.11.1.5) Intangible asset or liability for favorable or unfavorable terms (see Section 4.3.11.1.7), including favorable or unfavorable renewal or termination options (see Section 4.3.11.1.8) Leasehold improvements owned by the acquiree (see Section 4.3.11.1.9) Intangible asset for an in-place lease (see Section 4.3.11.1.10) Intangible asset for customer relationships (see Section 4.3.11.1.11)
Acquiree is the lessor in a sales-type or direct financing lease	Net investment in the lease (see Section 4.3.11.1.6) Intangible asset for an in-place lease (see Section 4.3.11.1.10) Intangible asset for customer relationships (see Section 4.3.11.1.11)

4.3.11.1.3 Acquiree Is the Lessee in an Operating or Finance Lease

ASC 805-20

25-10A An identifiable intangible asset may be associated with a lease, which may be evidenced by market participants’ willingness to pay a price for the lease even if it is at market terms. For example, a lease of gates at an airport or of retail space in a prime shopping area might provide entry into a market or other future economic benefits that qualify as identifiable intangible assets, such as a customer relationship. In that situation, the acquirer shall recognize the associated identifiable intangible asset(s) in accordance with paragraph 805-20-25-10.

25-11 The acquirer shall recognize assets or liabilities related to an operating lease in which the acquiree is the lessee as required by paragraphs 805-20-25-10A and 805-20-25-28A.

Measurement of Lease Assets and Lease Liabilities Arising From Leases in Which the Acquiree Is the Lessee

30-24 For leases in which the acquiree is a lessee, the acquirer shall measure the lease liability at the present value of the remaining lease payments, as if the acquired lease were a new lease of the acquirer at the acquisition date. The acquirer shall measure the right-of-use asset at the same amount as the lease liability as adjusted to reflect favorable or unfavorable terms of the lease when compared with market terms.

For acquired operating or finance leases in which the acquiree is the lessee, the acquirer measures the lease liability and ROU asset in accordance with the principles in ASC 842, and thus their measurement is an exception to ASC 805’s fair value measurement principle. (The acquirer may elect, as an accounting policy, not to recognize assets or liabilities as of the acquisition date for leases that, on the acquisition date, have a remaining lease term of 12 months or less; see Section 4.3.11.1.4.) The FASB considered whether to require an acquirer to apply the general measurement principle in ASC 805 and measure the acquiree’s ROU assets and lease liabilities at fair value as of the acquisition date but decided against it, as described in paragraph BC416 of ASU 2016-02:

[T]he Board decided that the benefits associated with measuring lease assets and lease liabilities at fair value will not justify the costs because obtaining fair value information — particularly for the right-of-use asset — might be difficult and, thus, costly. The Board also noted that when the acquiree is a lessee, the guidance on the measurement of lease assets and lease liabilities will result in recognizing a net carrying amount for the lease at the date of acquisition that approximates the fair value of the lease at that date.

Accordingly, ASC 805-20-30-24 requires an acquirer to measure “the lease liability at the present value of the remaining lease payments, as if the acquired lease were a new lease of the acquirer at the acquisition date.” The remaining lease payments are those expected to be received over the balance of the lease term and should be determined in accordance with the guidance in ASC 842-10-30-5, except that the commencement date for an acquired lease is the acquisition date. Paragraph BC415 of ASU 2016-02 clarifies that “[m]easuring the acquired lease as if it were a new lease at the date of acquisition includes undertaking a reassessment of all of the following:

The lease term
Any lessee options to purchase the underlying asset
Lease payments (for example, amounts probable of being owed by the lessee under a residual value guarantee)
The discount rate for the lease.”

We believe that the lease term should be assessed from the acquirer’s perspective. The acquirer should take into account any renewal or purchase options it expects to exercise (see Section 4.3.11.1.8) and use the discount rate that is implicit in the lease, if readily determinable; otherwise, the acquirer should use its incremental borrowing rate. In a manner consistent with how an entity would determine the incremental borrowing rate for a new lease, the acquirer should evaluate whether the incremental borrowing rate at the parent level (i.e., acquirer level) or the subsidiary level (i.e., acquiree level) would be appropriate on the basis of the terms and conditions of the lease arrangement. Regardless of this determination, the incremental borrowing rate used should be the rate determined as of the acquisition date. However, the acquirer would not reassess the acquiree’s lease classification solely on the basis of differences between the acquirer’s and acquiree’s assessment of the lease term or likelihood of purchase option exercise by the lessee. In other words, the acquirer will retain the lease classification of the acquiree’s leases, regardless of whether the acquirer’s and acquiree’s conclusions differ regarding lease term or purchase options, as long as the acquisition does not result in a lease modification that is not accounted for as a separate contract. (See Chapter 7 of Deloitte’s Roadmap Leases for additional information about the determination of the discount rate and measurement of a new lease under ASC 842 and Section 8.3.5.1.2 of Deloitte’s Roadmap Leases for subsequent accounting considerations for an acquirer that is reasonably certain to exercise a purchase option in an acquired operating lease.

ASC 805-20-30-24 also requires the acquirer to measure the “right-of-use asset at the same amount as the lease liability as adjusted to reflect favorable or unfavorable terms of the lease when compared with market terms.” Accordingly, an acquirer would not recognize a separate intangible asset or liability if an acquired lease in which the acquiree is a lessee is favorable or unfavorable relative to market terms as of the acquisition date. Thus, the acquirer will first measure the ROU asset in accordance with ASC 842 and then adjust the ROU asset for any off-market terms in accordance with ASC 805.

Connecting the Dots

ASC 842-10-55-12 states, in part, that “[l]eases between related parties should be classified in accordance with the lease classification criteria applicable to all other leases on the basis of the legally enforceable terms and conditions of the lease.” In addition, ASC 842-10-15-3A, which was added by ASU 2023-01, states, in part, that "as a practical expedient, an entity that is not a public business entity . . . may use the written terms and conditions of a related party arrangement between entities under common control to determine whether that arrangement is or contains a lease.” Therefore, under ASC 842, there are no circumstances in which entities would adjust the accounting for related-party leases for off-market terms or conditions. However, an ROU asset acquired in a business combination is adjusted for any off-market terms. We believe that even though it is not explicitly required to do so, an acquirer should, in a manner consistent with the measurement guidance in ASC 805 for all acquired ROU assets, adjust the carrying amount of an ROU asset acquired in a business combination for any off-market terms in a related-party lease. Otherwise, the off-market portion would be captured in goodwill (or possibly a bargain purchase gain) rather than through the amortization of the ROU asset.

In addition to the ROU asset and lease liability, when the acquiree is the lessee, an acquirer should recognize separately:

Leasehold improvements owned by the acquiree (see Section 4.3.11.1.9).
An intangible asset for the value associated with an in-place lease even if the lease is at market terms if market participants would place value on an at-the-money contract (see Section 4.3.11.1.10).

4.3.11.1.4 Leases With a Remaining Lease Term of 12 Months or Less in Which the Acquiree Is the Lessee

ASC 805-20

25-28B For leases for which the acquiree is a lessee, the acquirer may elect, as an accounting policy election by class of underlying asset and applicable to all of the entity’s acquisitions, not to recognize assets or liabilities at the acquisition date for leases that, at the acquisition date, have a remaining lease term of 12 months or less. This includes not recognizing an intangible asset if the terms of an operating lease are favorable relative to market terms or a liability if the terms are unfavorable relative to market terms.

The ASC master glossary defines a short-term lease as “[a] lease that, at the commencement date, has a lease term of 12 months or less and does not include an option to purchase the underlying asset that the lessee is reasonably certain to exercise.” Lessees may elect an accounting policy (by class of underlying asset to which the right of use relates) to not recognize on the balance sheet lease liabilities or ROU assets of short-term leases (i.e., the “short-term lease exemption”). Rather, a lessee that makes this accounting policy election recognizes (1) fixed lease payments as an expense on a straight-line basis over the lease term and (2) variable lease payments that do not depend on an index or rate as an expense in the period in which achieving the specified target that triggers the variable lease payments becomes probable. See Deloitte’s Roadmap Leases for further discussion.

ASC 842 amended ASC 805 to allow a similar exemption for leases acquired in a business combination on the basis of a remaining lease term of 12 months or less on the acquisition date. ASC 805-20-25-28B states, in part:

For leases for which the acquiree is a lessee, the acquirer may elect, as an accounting policy election by class of underlying asset and applicable to all of the entity’s acquisitions, not to recognize assets or liabilities at the acquisition date for leases that, at the acquisition date, have a remaining lease term of 12 months or less.

ASC 805-20-25-28B clarifies that the recognition exemption, when elected, also applies to intangible assets or liabilities for favorable or unfavorable terms of acquired operating leases. We also believe that this exception may be applied to in-place lease intangible assets.

4.3.11.1.5 Acquiree Is the Lessor in an Operating Lease

ASC 805-20

Assets Subject to Operating Leases in Which the Acquiree Is the Lessor

30-5 The acquirer shall measure the acquisition-date fair value of an asset, such as a building or a patent or other intangible asset, that is subject to an operating lease in which the acquiree is the lessor separately from the lease contract. In other words, the fair value of the asset shall be the same regardless of whether it is subject to an operating lease. In accordance with paragraph 805-20-25-12, the acquirer separately recognizes an asset or a liability if the terms of the lease are favorable or unfavorable relative to market terms.

The lessor in an operating lease continues to report the assets subject to the lease on its balance sheet. In a business combination in which the acquiree is a lessor, the assets subject to the lease are recognized by the acquirer and measured at their acquisition-date fair values. The fair value measurement of the assets does not take into consideration the terms of the lease arrangement. That is, ASC 805-20-30-5 clarifies that “the fair value of the asset shall be the same regardless of whether it is subject to an operating lease.”

In addition to the asset subject to the lease, an acquirer may recognize the following separately when the acquiree is the lessor in an operating lease:

An intangible asset or a liability if the terms of the lease are favorable or unfavorable compared with the market terms of leases of the same or similar items as of the acquisition date (see Section 4.3.11.1.7), including favorable or unfavorable renewal or termination options (see Section 4.3.11.1.8).
Leasehold improvements owned by the acquiree (see Section 4.3.11.1.9).
An intangible asset for the value associated with an in-place lease, including a lease that is at current market terms if market participants would place value on an at-the-money contract (see Section 4.3.11.1.10).
An intangible asset for the value of the existing customer relationship between the acquiree and its lessee (see Section 4.3.11.1.11).

4.3.11.1.6 Acquiree Is the Lessor in a Sales-Type or Direct Financing Lease

ASC 805-20

Measurement of Assets and Liabilities Arising From Leases in Which the Acquiree Is the Lessor

30-25 For leases in which the acquiree is a lessor of a sales-type lease or a direct financing lease, the acquirer shall measure its net investment in the lease as the sum of both of the following (which will equal the fair value of the underlying asset at the acquisition date):

The lease receivable at the present value, discounted using the rate implicit in the lease, of the following, as if the acquired lease were a new lease at the acquisition date:
1. The remaining lease payments
2. The amount the lessor expects to derive from the underlying asset following the end of the lease term that is guaranteed by the lessee or any other third party unrelated to the lessor.
The unguaranteed residual asset as the difference between the fair value of the underlying asset at the acquisition date and the carrying amount of the lease receivable, as determined in accordance with (a), at that date.

The acquirer shall take into account the terms and conditions of the lease in calculating the acquisition-date fair value of an underlying asset that is subject to a sales-type lease or a direct financing lease by the acquiree-lessor.

ASC 805-20-30-25 requires that when the acquiree is a lessor in a sales-type or direct financing lease, the acquirer must recognize the net investment in the lease — measured as the sum of the present value of the lease receivable and the unguaranteed residual asset — which should approximate fair value. The ASC master glossary defines a lease receivable as “[a] lessor’s right to receive lease payments arising from a sales-type lease or a direct financing lease plus any amount that a lessor expects to derive from the underlying asset following the end of the lease term to the extent that it is guaranteed by the lessee or any other third party unrelated to the lessor, measured on a discounted basis.” In the measurement of a lease receivable, it is assumed that the acquirer entered into the lease on the acquisition date under the terms in effect on that date. The measurement should include assessment of the lease term, any lessee options to purchase the underlying asset, lease payments, and the discount rate for the lease as described in paragraph BC415 of ASU 2016-02. See Deloitte’s Roadmap Leases for discussion about the measurement of a new lease under ASC 842.

The ASC master glossary defines an unguaranteed residual asset as “[t]he amount that a lessor expects to derive from the underlying asset following the end of the lease term that is not guaranteed by the lessee or any other third party unrelated to the lessor, measured on a discounted basis.” Such an asset is measured as “the difference between the fair value of the underlying asset at the acquisition date and the carrying amount of the lease receivable, as determined in accordance with [ASC 805-20-30-25(a)], at that date.” Because the measurement of the acquisition-date fair value of the underlying asset takes into account the terms and conditions of the existing lease arrangement, including any favorable or unfavorable terms, the acquirer does not recognize a separate intangible asset or liability for such off-market terms.

As described in paragraph BC417 of ASU 2016-02, the Board considered requiring an acquirer to apply the general principle in ASC 805 and measure the acquiree’s lease receivable and unguaranteed residual asset at fair value as of the acquisition date but ultimately decided against such an approach:

The Board considered requiring the measurement of the net investment in the lease and its components — both the lease receivable and the unguaranteed residual asset — at fair value at the date of acquisition. However, the Board noted that there will be costs associated with measuring each of those assets at fair value and that it had decided not to require such a measurement basis for the lease receivable and the unguaranteed residual asset more generally because of those costs. Although the proposed initial measurement of the lease receivable and the unguaranteed residual asset may not represent the fair value of those assets, the sum of the initial measurement of those assets (that is, the net investment in the lease) will equal the fair value of the underlying asset, which is consistent with the principles in Topic 805. Consequently, the Board concluded that the benefits of requiring an acquirer to measure the lease receivable and the unguaranteed residual asset at fair value will not justify the costs.

The net investment in the lease is subsequently accounted for in accordance with ASC 842. See Deloitte’s Roadmap Leases for more information on the subsequent accounting for the net investment in a sales-type or direct financing lease.

In addition to the net investment in the lease, an acquirer may recognize the following separately when the acquiree is the lessor in a sales-type or direct financing lease:

An intangible asset for the value associated with an in-place lease, including a lease that is at current market terms if market participants would place value on an at-the-money contract (see Section 4.3.11.1.10).
An intangible asset for the value of the existing customer relationship between the acquiree and its lessees (see Section 4.3.11.1.11).

4.3.11.1.7 Favorable or Unfavorable Terms in Leases

ASC 805-20

25-12 Regardless of whether the acquiree is the lessee or the lessor, the acquirer shall determine whether the terms of each of an acquiree’s operating leases are favorable or unfavorable compared with the market terms of leases of the same or similar items at the acquisition date. If the acquiree is a lessor, the acquirer shall recognize an intangible asset if the terms of an operating lease are favorable relative to market terms and a liability if the terms are unfavorable relative to market terms. If the acquiree is a lessee, the acquirer shall adjust the measurement of the acquired right-of-use asset for any favorable or unfavorable terms in accordance with paragraph 805-20-30-24.

One or more of an acquiree’s leases may be favorable or unfavorable (i.e., off-market) as of the acquisition date compared with the market terms of leases of the same or similar items. From the perspective of the acquirer, a favorable lease represents an asset, while an unfavorable lease represents a liability (balance sheet credit). The acquirer accounts for each favorable or unfavorable lease as of the acquisition date as follows:

Lease Type	Asset or Liability That May Be Recognized
Acquiree is the lessee in an operating or finance lease	The acquirer adjusts the measurement of the ROU asset for any off-market terms (see Section 4.3.11.1.3).
Acquiree is the lessee and the remaining lease term is 12 months or less	The acquirer may make an accounting policy election not to recognize assets or liabilities for short-term leases, including intangible assets or liabilities for off-market terms or in-place leases (see Section 4.3.11.1.4).
Acquiree is the lessor in an operating lease	The acquirer recognizes a separate intangible asset or liability for off-market terms (see Section 4.3.11.1.5). Assets and liabilities should be recognized separately and not offset.
Acquiree is the lessor in a sales-type or direct financing lease	The acquirer adjusts the measurement of the underlying asset for any off-market terms (see Section 4.3.11.1.6), which affects the measurement of the unguaranteed residual asset (in accordance with ASC 805-20-30-25) and thus the measurement of the net investment in the lease.

Connecting the Dots

The above guidance on the recognition of favorable or unfavorable terms in a lease arrangement also applies to sublease transaction scenarios in which the lessee (i.e., intermediate lessor) is not relieved of its primary obligation under the head lease arrangement. For example, if the acquiree is the lessee in a sublease transaction, it would adjust the measurement of its ROU asset for any off-market terms as if it were the lessee in a normal lease arrangement. Likewise, if the acquirer is the intermediate lessor in a sublease transaction, it would account for the off-market terms as if it were the lessor in a normal lease arrangement. Thus, it would either recognize a separate intangible asset or liability or recognize an adjustment to the measurement of the underlying asset, depending on the classification of the sublease as either an operating lease or a sales-type or direct financing lease. See Deloitte’s Roadmap Leases for more information about sublease arrangements.

4.3.11.1.8 Renewal or Termination Options in a Lease

An acquired lease may include a renewal or termination option that the acquirer may factor into the lease term and include in the measurement and recognition of the lease. The ASC master glossary defines lease term as follows:

The noncancellable period for which a lessee has the right to use an underlying asset, together with all of the following:

Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option
Periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option
Periods covered by an option to extend (or not to terminate) the lease in which exercise of the option is controlled by the lessor.

Accordingly, whether a renewal period is factored into a lease term depends on whether it is reasonably certain that the renewal option will be exercised. Similarly, whether the period after a termination option is factored into the lease term depends on whether it is reasonably certain that the termination option will not be exercised. As discussed in Section 4.3.11.1.1, if the acquiree (at lease commencement) and the acquirer (on the acquisition date) reach different conclusions about the likelihood of exercising an option to extend or terminate a lease, the classification of the acquired lease does not change unless the lease is modified and the modification is not accounted for as a separate contract. The following table summarizes the acquirer’s accounting for renewal or termination options:

Acquiree is the lessee in an operating or financing lease	If the lease term includes a period covered by a renewal option (or an option not to terminate), the favorability or unfavorability of the option is considered in the measurement of the ROU asset.
Acquiree is the lessor in an operating lease	If the lease term includes a period covered by a renewal option (or an option not to terminate), the acquirer separately recognizes (1) an intangible asset if the terms of an operating lease are favorable relative to market terms or (2) a liability if the terms are unfavorable relative to market terms. That is, the measurement of any favorable lease asset or unfavorable lease liability includes any favorable or unfavorable renewal or termination options.
Acquiree is the lessor in a sales-type or direct financing lease	If the lease term includes a period covered by a renewal option (or an option not to terminate), the acquirer does not separately recognize (1) an intangible asset if the terms of the lease are favorable relative to market terms or (2) a liability if the terms are unfavorable relative to market terms. Rather, the favorable or unfavorable terms of the renewal option are considered in the measurement of the lease receivable and unguaranteed residual asset (i.e., the net investment in the lease).

4.3.11.1.9 Leasehold Improvements

ASC 805-20

35-6 Leasehold improvements acquired in a business combination shall be amortized over the shorter of the useful life of the assets and the remaining lease term at the date of acquisition. However, if the lease transfers ownership of the underlying asset to the lessee, or the lessee is reasonably certain to exercise an option to purchase the underlying asset, the lessee shall amortize the leasehold improvements to the end of their useful life.

ASC 842-20

35-13 Leasehold improvements acquired in a business combination or an acquisition by a not-for-profit entity shall be amortized over the shorter of the useful life of the assets and the remaining lease term at the date of acquisition.

Acquired leasehold improvements that are owned by the acquiree are measured at their acquisition-date fair values. ASC 805-20-35-6 requires such improvements, once recognized, to be amortized over the shorter of the remaining lease term or the useful life of those assets, as determined by the acquirer, unless (1) “the lease transfers ownership of the underlying asset to the lessee” or (2) “the lessee is reasonably certain to exercise an option to purchase the underlying asset,” in which case the acquirer is required to amortize the leasehold improvements to the end of their useful life.

The existence of leasehold improvements owned by the acquiree can affect the acquirer’s determination of the lease term (and thus of the acquirer’s measurement of lease assets and lease liabilities). As discussed in Sections 4.3.11.1.3 and 4.3.11.1.6, the acquirer measures the acquired lease as if it were a new lease on the acquisition date, which includes undertaking a reassessment of the lease term (and other inputs). For example, if, as of the acquisition date, the acquiree/lessee has significant leasehold improvements, the acquirer may be likely to exercise a renewal option if failing to do so would result in the loss of those improvements with a remaining useful life.

For additional information about the accounting for leasehold improvements (including the importance of determining which party owns the improvements and the issuance of ASU 2023-01 related to the accounting for leasehold improvements in common-control arrangements), see Deloitte’s Roadmap Leases.

4.3.11.1.10 Intangible Assets for In-Place Lease Value

ASC 805-20

An in-place lease intangible asset represents the price that a market participant would be willing to pay for an at-market lease. The value associated with an in-place lease reflects, for example, the value associated with avoiding (1) the costs of originating an acquired lease (such as the costs to execute the lease, including marketing costs, sales or leasing commissions, and legal and other related costs) and (2) costs that would be incurred if an asset that was intended to be leased was acquired without a lessee.

An intangible asset for an in-place lease should be recognized separately in the financial statements and not combined with other lease-related assets or liabilities (e.g., not combined with lessee ROU assets, lessor net investments in leases, intangible assets for favorable lease terms, or liabilities for unfavorable lease terms).

4.3.11.1.11 Customer-Relationship Intangible Assets — Acquiree Is the Lessor

Regardless of the classification of a lease as operating, sales-type, or direct financing, if the acquiree is the lessor, the lease contract may provide value to the acquirer as a result of the existing relationship between the acquiree and its lessee (i.e., customer). Accordingly, the acquirer in a business combination may recognize a separate intangible asset for that customer relationship if it is identifiable (i.e., arises from contractual rights or is separable). Because, as noted in ASC 805-20-55-24, the assets’ useful lives and the pattern in which their economic benefits are consumed may differ, the acquirer may need to recognize separately the assets and liabilities that are related to a single lessee. See Section 4.10.4.2 for more information about customer-related intangible assets.

The interrelationship of various types of intangible assets associated with the same lessee can pose challenges in the recognition and measurement of a customer-related intangible asset. The values assigned to other assets and liabilities — such as lease receivables, off-market contracts, and in-place lease intangible assets — may also affect the valuation of customer-related intangible assets.

4.3.11.1.12 Prepaid or Accrued Rent

Assets or liabilities for prepaid or accrued rent are not recognized under ASC 805 regardless of whether the acquiree is the lessee or the lessor in a lease. Paragraph BC415 of ASU 2016-02 clarifies that:

The acquiree’s right-of-use asset should be measured at the amount of the lease liability, adjusted for any off-market terms (that is, favorable or unfavorable terms) present in the lease. Prepaid or accrued rent should not be recognized [in a business combination] because such amounts do not meet the definition of an asset or a liability in Concepts Statement 6 under the acquisition method of Topic 805, Business Combinations. Instead, the remaining lease payments required under the terms of the lease are considered in evaluating whether the terms of the lease are favorable or unfavorable at the acquisition date.

When an entity enters into a lease, the terms of the lease are presumed to be at market even if the arrangement includes up-front or deferred payments (i.e., the total amount of the payments is presumed to reflect the market rate). However, if a lease with prepaid or deferred payments is acquired in a business combination, the remaining lease payments may be more or less than they would be for a new lease of the property with the same remaining term. As a result, the lease may be above or below market as of the acquisition date. See Section 4.3.11.1.7 for the accounting for off-market terms, which depend on whether the acquiree is the lessee or the lessor and the classification of the lease.

4.3.11.1.13 Variable Lease Payments

The terms of a lease are presumed to be at market even if the lease includes variable payments that are based on the use or performance of the underlying asset (i.e., the total amount of the expected payments is presumed to reflect the market rate). If such a lease is acquired in a business combination, the remaining lease payments may be more or less than the lease payments would be for a new lease of the property with the same remaining term. Consequently, an acquirer may determine that an acquired lease with variable payments is above or below market as of the acquisition date. See Section 4.3.11.1.7 for more information on the accounting for leases with off-market terms, which depends on whether the acquiree is the lessee or the lessor and the classification of the lease.

4.3.11.1.14 Leveraged Leases

ASC 842-50

Leveraged Lease Acquired in a Business Combination or an Acquisition by a Not-for-Profit Entity

25-2 In a business combination or an acquisition by a not-for-profit entity, the acquiring entity shall retain the classification of the acquired entity’s investment as a lessor in a leveraged lease at the date of the combination. The net investment of the acquired leveraged lease shall be disaggregated into its component parts, namely net rentals receivable, estimated residual value, and unearned income including discount to adjust other components to present value.

30-2 In a business combination or an acquisition by a not-for-profit entity, the acquiring entity shall assign an amount to the acquired net investment in the leveraged lease in accordance with the general guidance in Topic 805 on business combinations, based on the remaining future cash flows and giving appropriate recognition to the estimated future tax effects of those cash flows.

35-1 In a business combination or an acquisition by a not-for-profit entity, the acquiring entity shall subsequently account for its acquired investment as a lessor in a leveraged lease in accordance with the guidance in this Subtopic as it would for any other leveraged lease.

On the adoption date of ASC 842, leases that were previously classified as leveraged leases under ASC 840 are subject to the guidance in ASC 842-50, which is generally consistent with the accounting requirements for leveraged leases in ASC 840 and effectively carries forward that guidance. However, if a leveraged lease is modified after the entity adopts ASC 842, it is accounted for as a new lease in accordance with ASC 842 (i.e., classification is reassessed and leveraged lease accounting would no longer be available). Entities are not permitted to account for any new lease arrangements as leveraged leases after the adoption of ASC 842.

If a leveraged lease is acquired in a business combination after the adoption of ASC 842, the acquirer does not reassess the lease’s classification (unless it is modified on or after the date of acquisition) and must apply the recognition, measurement, presentation, and disclosure guidance for leveraged leases in ASC 842-50. If the acquired leveraged lease is modified as part of the business combination, it should be reclassified in accordance with the lease classification guidance in ASC 842. As discussed in Section 4.3.11.1.1, a modification is a change in the scope of or consideration for a lease. Changing the parties identified in a lease contract would not change the classification of a leveraged lease because such a change does not alter the scope of or consideration for the lease.

If the acquiree is a lessor in a leveraged lease that is not modified as part of the business combination, the acquirer measures the net investment on the basis of the remaining net future cash flows and gives appropriate recognition to the estimated future tax effects of such cash flows. The net investment is then broken down into its component parts (i.e., net rentals receivable, estimated residual value, and unearned income, including the discount to adjust the other components to present value), which are recognized as of the acquisition date. After the acquisition, the acquirer accounts for the investment in the leveraged lease in accordance with ASC 842-50.

Example 4 in ASC 842-50-55-27 through 55-33 illustrates the accounting for a leveraged lease acquired in a business combination. Also, see Deloitte’s Roadmap Leases for more information about the accounting for leveraged leases.

4.3.11.1.15 Sale-and-Leaseback Transactions

A sale-and-leaseback transaction is a common financing method that involves the transfer of an asset from the owner to a buyer and a leaseback of that asset to the seller. The buyer/lessor in a sale-and-leaseback transaction receives a steady return on its investment in the form of annual rental payments and may receive certain tax advantages. Furthermore, the buyer/lessor obtains the benefits of owning the asset, including any future asset appreciation.

If the initial transfer of the asset is determined to be a sale in accordance with ASC 842-40 and ASC 606, the transaction is accounted for as a sale and leaseback under ASC 842-40. The seller/lessee derecognizes the underlying asset, recognizes any gain or loss on the sale, and accounts for the leaseback as it would any other operating lease. The buyer/lessor recognizes the underlying asset and accounts for the lease as it would any other operating or direct financing lease. If the seller/lessee or buyer/lessor in a sale-and-leaseback transaction is subsequently acquired in a business combination, the acquirer should account for the leaseback as described in Sections 4.3.11.1.1 through 4.3.11.1.14.

If the initial transfer does not meet the criteria to be a sale in accordance with ASC 842-40 and ASC 606 (i.e., it is a “failed” sale and leaseback), the seller/lessee and the buyer/lessor account for the transaction as a financing transaction. The seller/lessee continues to report the property on its balance sheet as if it were its owner and recognizes a financial liability (i.e., debt). The buyer/lessor does not recognize the property on its balance sheet and instead recognizes a financial asset (i.e., a loan receivable). If the seller/lessee or buyer/lessor in a failed sale-and-leaseback transaction is subsequently acquired in a business combination, the acquirer should not reassess the transaction. For example, the acquirer may continue to use the acquiree’s accounting for the failed sale-and-leaseback transaction until the transaction meets the requirements in ASC 842-40 and ASC 606 for the transfer to be accounted for as a sale. The assets and liabilities related to the arrangement should be measured at their acquisition-date fair values.

In addition, there may be situations in which a third party acquires an asset directly from the acquiree before or concurrently with the business combination and subsequently leases the asset back to the acquirer after the acquisition. In substance, such arrangements may represent sale-and-leaseback transactions if it is determined that the acquirer or future lessee controls the asset before or concurrently with the acquisition. See Chapter 10 of Deloitte’s Roadmap Leases for more information.

4.3.11.1.16 Preexisting Leases Between the Acquirer and Acquiree

An acquirer and an acquiree may have a preexisting lease arrangement that was entered into before negotiations for the business combination began. As described in Section 6.2.2, a preexisting relationship between an acquirer and acquiree is considered effectively settled as part of the business combination even if it is not legally cancelled, because it becomes an intercompany relationship upon the acquisition and is eliminated in consolidation in the postcombination financial statements. Thus, the acquirer does not recognize any lease assets or lease liabilities related to the preexisting lease. In accordance with ASC 805-10-55-21(b), it recognizes a gain or loss on the settlement of the lease in an amount equal to the lesser of (1) “[t]he amount by which the [lease] is favorable or unfavorable from the perspective of the acquirer” relative to market terms or (2) “[t]he amount of any stated settlement provisions in the [lease] available to the counterparty to whom the contract is unfavorable.”

In addition, the acquirer should consider whether it has recognized any assets or liabilities related to the lease that should be derecognized as part of the effective settlement of the arrangement. The carrying amounts of the recognized assets or liabilities, if any, would adjust the amount of the gain or loss recognized for the settlement of the preexisting relationship, as illustrated in Example 3 in ASC 805-10- 55-33 (reproduced in Section 6.2.2.3).

4.3.11.2 Leases — Before Adoption of ASC 842

Leases (including contracts that contain a lease) acquired in a business combination may result in the recognition of various assets or liabilities, depending on the classification of the lease and whether the acquiree is the lessee or lessor. The subsections that follow describe the accounting for leases acquired in a business combination before the adoption of ASC 842.

4.3.11.2.1 Classification

ASC 805-20

Classifying or Designating Identifiable Assets Acquired and Liabilities Assumed in a Business Combination

25-8 This Section provides the following two exceptions to the principle in paragraph 805-20-25-6:

Classification of a lease contract as either an operating lease or a capital lease in accordance with the guidance in paragraph 840-10-25-27 . . . .

ASC 840-10

35-5 The classification of a lease in accordance with the criteria in this Subtopic shall not be changed as a result of a business combination or an acquisition by a not-for-profit entity unless the provisions of the lease are modified. At the acquisition date, an acquirer may contemplate renegotiating and modifying leases of the business or nonprofit activity acquired. Modifications made after the acquisition date, including those that were planned at the time of the combination, are postcombination events that shall be accounted for separately by the acquirer in accordance with the provisions of this Topic. If in connection with a business combination or an acquisition by a not-for-profit entity the provisions of a lease are modified in a way that would require the revised agreement to be considered a new agreement under the preceding paragraph, the new lease shall be classified by the combined entity according to the criteria set forth in this Subtopic, based on conditions as of the date of the modification of the lease. After the recording of the amounts called for by Subtopic 805-20, the leases shall be accounted for in accordance with this Subtopic. Subtopic 840-30 explains the application of this paragraph to a leveraged lease by an entity that acquires a lessor. This Subtopic does not address the subsequent accounting for amounts recorded for favorable or unfavorable operating leases.

As indicated in ASC 805-20-25-6, if a lease is modified as part of a business combination, the acquirer reconsiders the acquiree’s classification of the lease. Otherwise, the acquiree’s classification generally carries over to the acquirer. See Section 4.2 for more information.

If the terms of a lease are modified as part of the business combination and the lease qualifies as a new lease in accordance with ASC 840-10-35-4, the acquirer classifies the lease as of the acquisition date on the basis of the modified lease terms.

Alternatively, a lease might be changed as part of a business combination in ways that do not qualify as a lease modification. For example, a lease may be changed to reflect the new owner of the acquiree. Such a change in the name of one of the parties identified in the contract would not qualify as a lease modification without a change in the scope of or consideration for the lease.

4.3.11.2.2 Potential Assets or Liabilities Related to an Acquiree’s Leases

Under ASC 805, most assets acquired and liabilities assumed are measured and recognized at fair value, including lease-related assets and liabilities that are recognized before the adoption of ASC 842. The table below lists the potential assets or liabilities that may be recognized in connection with an acquiree’s leases. Each item is discussed in more detail in the sections noted.

Lease Type	Asset or Liability That May Be Recognized
Acquiree is the lessee in an operating lease	No recognition of lease asset or lease liability (see Section 4.3.11.2.3) Leasehold improvements owned by the lessee (see Section 4.3.11.2.7) Intangible asset or liability for favorable or unfavorable terms (see Section 4.3.11.2.8) Intangible asset for an in-place lease (see Section 4.3.11.2.9)
Acquiree is the lessee in a capital lease	Property subject to the lease (see Section 4.3.11.2.4) Capital lease obligation (see Section 4.3.11.2.4) Leasehold improvements owned by the lessee (see Section 4.3.11.2.7) Intangible asset for an in-place lease (see Section 4.3.11.2.9)
Acquiree is the lessor in an operating lease	Property subject to the lease (see Section 4.3.11.2.5) Leasehold improvements owned by the lessor (see Section 4.3.11.2.7) Intangible asset or liability for favorable or unfavorable terms (see Section 4.3.11.2.8) Intangible asset for an in-place lease (see Section 4.3.11.2.9) Intangible asset for customer relationships (see Section 4.3.11.2.10)
Acquiree is the lessor in a sales-type or direct financing lease	Net investment in the lease (see Section 4.3.11.2.6) Intangible asset for an in-place lease (see Section 4.3.11.2.9) Intangible asset for customer relationships (see Section 4.3.11.2.10)

4.3.11.2.3 Acquiree Is the Lessee in an Operating Lease

ASC 805-20

Operating Leases

25-11 The acquirer shall recognize no assets or liabilities related to an operating lease in which the acquiree is the lessee except as required by paragraphs 805-20-25-12 through 25-13.

For acquired operating leases in which the acquiree is the lessee, ASC 840 and ASC 805 prohibit recognition of a separate asset for the right to use the underlying asset or a separate liability for the remaining minimum lease payments.

However, an acquirer may recognize other assets or liabilities, such as:

Any leasehold improvements owned by the acquiree (see Section 4.3.11.2.7).
An intangible asset or a liability if the terms of the lease (including renewal or purchase options) are favorable or unfavorable relative to current market terms for similar leases (see Section 4.3.11.2.8).
An intangible asset for the value associated with an in-place lease, including a lease at current market terms if market participants would place value on an at-the-money contract (see Section 4.3.11.2.9).

4.3.11.2.4 Acquiree Is the Lessee in a Capital Lease

An entity may acquire a capital lease in which the acquiree is the lessee. Capital lease assets and lease obligations must be separately recognized and measured at fair value as of the acquisition date.

Before measuring a capital lease asset, the acquirer must determine whether it expects to obtain ownership of the leased property at the end of the lease term. It must consider all facts and circumstances, including the terms of the contract, whether it contains a bargain purchase option, and entity-specific factors. If the acquirer expects to obtain ownership of the property subject to the capital lease, it measures the lease asset at the fair value of the underlying property. If the acquirer does not expect to obtain ownership of the property subject to the capital lease, it measures the lease asset at the fair value of the leasehold interest, which is the fair value of the right to use the property until the end of the lease term.

The acquirer also recognizes a liability at fair value for the remaining minimum lease payments. The assumptions used in measuring the liability should be consistent with those used in measuring the asset (e.g., the same lease term should be used in measuring both the asset and the liability).

In addition, when the acquiree is the lessee in a capital lease, the acquirer may recognize other assets or liabilities, such as:

Any leasehold improvements owned by the acquiree (see Section 4.3.11.2.7).
An intangible asset for the value associated with an in-place lease, including a lease at current market terms if market participants would place value on an at-the-money contract (see Section 4.3.11.2.9).

4.3.11.2.5 Acquiree Is the Lessor in an Operating Lease

ASC 805-20

Assets Subject to Operating Leases in Which the Acquiree Is the Lessor

The lessor in an operating lease continues to report the assets subject to the lease on its balance sheet. In a business combination in which the acquiree is a lessor, the assets subject to the lease are recognized by the acquirer and measured at their acquisition-date fair values. The fair value measurement of the assets does not take into consideration the terms or conditions of the lease arrangement. That is, ASC 805-20-30-5 clarifies that “the fair value of the asset shall be the same regardless of whether it is subject to an operating lease.”

In addition to the property subject to the lease, an acquirer may recognize the following separately when the acquiree is the lessor in an operating lease:

Any leasehold improvements owned by the acquiree (see Section 4.3.11.2.7).
An intangible asset or a liability if the terms of the lease (including renewal or purchase options) are favorable or unfavorable relative to current market terms for similar leases (see Section 4.3.11.2.8).
An intangible asset for the value associated with an in-place lease, including a lease at current market terms if market participants would place value on an at-the-money contract (see Section 4.3.11.2.9).
An intangible asset for the value of the existing customer relationship between the acquiree and its lessees (see Section 4.3.11.2.10).

4.3.11.2.6 Acquiree Is the Lessor in a Sales-Type or Direct Financing Lease

When the acquiree is a lessor in a sales-type or direct financing lease, the acquirer recognizes and measures at fair value its net investment in the lease. The lessor’s remaining net investment in the lease includes the residual value, if any, of the leased asset and any renewal or purchase options.

In addition to the net investment in the lease, the acquirer may recognize the following separately when the acquiree is the lessor in a sales-type or direct financing lease:

An intangible asset for the value associated with an in-place lease, including a lease at current market terms if market participants would place value on an at-the-money contract (see Section 4.3.11.2.9).
An intangible asset for the value of the existing customer relationship between the acquiree and its lessees (see Section 4.3.11.2.10).

4.3.11.2.7 Leasehold Improvements

ASC 805-20

35-6 Leasehold improvements acquired in a business combination shall be amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals that are deemed to be reasonably assured (as used in the definition of lease term) at the date of acquisition.

Acquired leasehold improvements that are owned by the acquiree are measured at their acquisition-date fair values. ASC 805-20-35-6 requires that acquirers amortize leasehold improvements “over the shorter of the useful life of the assets or a term that includes required lease periods and renewals that are deemed to be reasonably assured.” Therefore, to determine the amortization period of leasehold improvements acquired in a business combination, acquirers must evaluate as of the acquisition date both the useful life of those improvements and the required lease periods and renewals that are deemed to be reasonably assured.

When determining the required lease periods and renewals that are deemed to be reasonably assured, entities should consider the definition of lease term in the ASC master glossary, which states that the term should include “[a]ll periods, if any, for which failure to renew the lease imposes a penalty on the lessee in such amount that a renewal appears, at lease inception, to be reasonably assured.” Acquirers should assess whether the renewal options are bargain renewal options or whether failure to renew would impose a significant penalty, and, on the basis of that assessment, use judgment to determine whether the renewal options are reasonably assured. If, as of the acquisition date, the acquiree has significant leasehold improvements, the acquirer may assume that it is reasonably assured that the acquiree will exercise its renewal options because the loss of the improvements that would result from the failure to renew the lease would impose a significant penalty.

4.3.11.2.8 Intangible Asset or Liability Related to Favorable or Unfavorable Operating Leases

ASC 805-20

One or more of an acquiree’s lease contracts may be favorable or unfavorable (i.e., off-market) as of the acquisition date relative to current market terms. ASC 805-20-25-12 applies to all operating leases regardless of whether the acquiree was the lessee or the lessor.

From the perspective of the acquirer, a favorable lease represents an asset, while an unfavorable lease represents a liability (balance sheet credit). Some lease contracts may result in the recognition of an intangible asset and others may result in the recognition of a liability. Entities should present intangible assets and liabilities separately on the balance sheet.

The acquirer must consider any renewal options or purchase options in the valuation of an intangible asset or liability as follows:

If the acquiree is the lessee in an operating lease and the exercise of options is within the acquiree/lessee’s control:
- Renewal or purchase options that are favorable to the acquiree/lessee are generally considered in the valuation of the intangible asset or liability.
- Renewal or purchase options that are unfavorable to the acquiree/lessee are generally not considered in the valuation of the intangible asset or liability since the acquirer would not be expected to exercise an unfavorable option.
If the acquiree is the lessor in an operating lease and the exercise of options is within the lessee’s control:
- Renewal or purchase options that are unfavorable to the acquiree/lessor are generally considered in the valuation of the intangible asset or liability.
- Renewal or purchase options that are favorable to the acquiree/lessor are generally not considered in the valuation of the intangible asset or liability since the lessee would not be expected to exercise an unfavorable option.

4.3.11.2.9 Intangible Assets for In-Place Lease Value

ASC 805-20

25-13 An identifiable intangible asset may be associated with an operating lease, which may be evidenced by market participants’ willingness to pay a price for the lease even if it is at market terms. For example, a lease of gates at an airport or of retail space in a prime shopping area might provide entry into a market or other future economic benefits that qualify as identifiable intangible assets, such as a customer relationship. In that situation, the acquirer shall recognize the associated identifiable intangible asset(s) in accordance with paragraph 805-20-25-10.

The value of an in-place lease represents the price that a market participant would be willing to pay for an at-market lease. An intangible asset for the value associated with an in-place lease may exist regardless of (1) the lease classification and (2) whether the acquiree is the lessor or the lessee.

A lease that is in place on the acquisition date may provide value to the lessee because it gives the lessee access to property that is unique or scarce and may permit future contract renewals or extensions.

An in-place lease may also provide value to the lessor by allowing it to avoid certain cash outflows to originate the lease (such as marketing, sales commissions, legal costs, and lease incentives) and lost cash flows during an otherwise required lease-up period. Accordingly, measurement of in-place lease intangible assets should reflect both of these benefits to the acquirer (net of service costs to tenants, such as security and maintenance).

4.3.11.2.10 Customer-Related Intangible Assets — Acquiree Is the Lessor

Regardless of the classification of a lease as operating, sales-type, or direct financing, if the acquiree is the lessor, a lease contract may provide value to the acquirer as a result of the existing relationship between the acquiree and its lessee (i.e., customer). Accordingly, the acquirer in a business combination recognizes a separate intangible asset for that customer relationship if it is identifiable (i.e., arises from contractual rights or is separable). Because, as noted in ASC 805-20-55-24, the assets’ useful lives and the pattern in which their economic benefits are consumed may differ, the acquirer may need to recognize separately the assets and liabilities that are related to a single lessee. See Section 4.10.4.2 for more information about customer-related intangible assets.

4.3.11.2.11 Deferred Rent

Before the acquisition date, an acquiree may have recognized an asset or a liability for deferred rent related to an operating lease. The recognition of deferred rent results from the guidance in ASC 840-20-25-2 that generally requires lessees and lessors to recognize scheduled rent increases on a straight-line basis over the lease term.

In a business combination, the acquirer does not recognize the acquiree’s deferred rent balance because it does not meet the definition of an asset or liability. The impact of any previously recognized asset or liability of the acquiree for deferred rent would be captured in the fair value measurement of an intangible asset or liability for favorable or unfavorable terms (see Section 4.3.11.2.8). After a business combination, the acquirer accounts for any acquired leases in accordance with ASC 840. Accordingly, the acquirer recognizes any deferred rent starting from the acquisition date in the postcombination period on the basis of the terms of the assumed lease.

Example 4-6

Accounting for Deferred Rent in a Business Combination

On January 1, 20X6, Company B enters into a four-year operating lease. The payments required under the lease escalate each year. The following table illustrates the calculation of the deferred rent (1) liability, if B is the lessee, or (2) asset, if B is the lessor, at the end of each of years 1 through 4:

On January 1, 20X8 (i.e., the end of year 2), Company A acquires B and accounts for the acquisition as a business combination. As of the acquisition date, A does not record an asset or a liability for B’s deferred rent, regardless of whether B is the lessee or the lessor. However, starting on the acquisition date, A will account for the acquired lease in accordance with ASC 840 and will begin recognizing deferred rent in the postcombination period. The following table illustrates the calculation of the deferred rent (1) liability, if B is the lessee, or (2) asset, if B is the lessor at the end of years 3 and 4:

4.3.11.2.12 Sale-Leaseback Transactions

A sale-leaseback transaction is a common financing method that involves the transfer of an asset from the owner to a buyer and a leaseback of that asset to the seller. The buyer/lessor in a sale-leaseback transaction receives a steady return on its investment in the form of annual rental payments and may receive certain tax advantages. Furthermore, the buyer/lessor obtains the benefits of owning the asset, including any future asset appreciation.

If the initial transfer of the asset is determined to be a sale, the transaction is accounted for as a sale-leaseback under ASC 840-40. If the sale-leaseback does not meet the criteria for a sale (i.e., it is a “failed” sale-leaseback), the seller’s/lessee’s accounting for the transaction depends on the type of underlying asset. If the underlying asset is equipment, the seller/lessee accounts for the transaction as a financing transaction — that is, it continues to recognize the asset on its balance sheet as if it were its owner and recognizes a liability. If the underlying asset is real estate, the seller/lessee accounts for the transaction either as a financing transaction or by using the deposit method, depending on the facts and circumstances.

If the seller/lessee is subsequently acquired in a business combination, the acquirer should not reassess the transaction. For example, the acquirer should continue with the acquiree’s accounting for a failed sale-leaseback transaction until the transaction meets the requirements in ASC 840-40 to be accounted for as a sale. The assets and liabilities related to the arrangement should be measured at their acquisition-date fair values.

4.3.11.2.13 Preexisting Leases Between the Acquirer and Acquiree

An acquirer and acquiree may have a preexisting lease arrangement that was entered into before negotiations for the business combination began. As described in Section 6.2.2, a preexisting relationship between an acquirer and acquiree is considered effectively settled as part of the business combination even if it is not legally cancelled because it becomes an intercompany relationship upon the acquisition and is eliminated in consolidation in the postcombination financial statements. Thus, the acquirer does not recognize any lease assets or lease liabilities related to the preexisting lease. In accordance with ASC 805-10-55-21(b), it recognizes a gain or loss on the settlement of the lease in an amount equal to the lesser of (1) “[t]he amount by which the [lease] is favorable or unfavorable from the perspective of the acquirer” relative to market terms or (2) “[t]he amount of any stated settlement provisions in the [lease] available to the counterparty to whom the contract is unfavorable.”

4.3.12 Insurance or Reinsurance Contracts

As part of deliberating Statement 141(R) (codified in ASC 805), the FASB established specific guidance on accounting for insurance and reinsurance contracts acquired in a business combination.

4.3.12.1 Classification of Contracts

In a manner consistent with the concept that a business combination results in the initial recognition of an acquiree’s assets and liabilities in the acquirer’s financial statements, most contracts, assets, and liabilities are classified or designated as of the acquisition date as if they were entered into or acquired on that date. ASC 805 provides for two exceptions to that concept, one of which is the classification of contracts as insurance or reinsurance contracts.

ASC 805-20-25-8(b) requires an acquirer to carry forward the classification of an acquired contract as an insurance or a reinsurance contract (rather than a deposit) that the acquiree made at the inception of the contract on the basis of its terms and any related contracts or agreements. If the terms of those contracts or agreements were modified in a way that would change their classification, the acquirer determines the classification of the contract on the basis of its terms and other pertinent factors on the modification date, which may be the acquisition date. When assessing whether a contract qualifies as insurance or reinsurance, an entity must consider related contracts and arrangements because they can significantly affect the amount of risk transferred.

4.3.12.2 Recognition and Measurement of Insurance Contracts

ASC 944-805

30-1 The acquirer shall measure at fair value the assets and liabilities recognized under paragraph 944-805-25-3. However, the acquirer shall recognize that fair value in components as follows:

Assets and liabilities measured in accordance with the acquirer’s accounting policies for insurance and reinsurance contracts that it issues or holds. For example, the contractual assets acquired could include a reinsurance recoverable and the liabilities assumed could include a liability to pay future contract claims and claims expenses on the unexpired portion of the acquired contracts and a liability to pay incurred contract claims and claims expenses. However, those assets acquired and liabilities assumed would not include the acquiree’s deferred acquisition costs and unearned premiums that do not represent future cash flows.
An intangible asset (or occasionally another liability), representing the difference between the following:
1. The fair value of the contractual insurance and reinsurance assets acquired and liabilities assumed
2. The amount described in (a).

30-2 Other related contracts that are not insurance or reinsurance contracts shall be measured at the date of acquisition in accordance with Topic 805.

The assets and liabilities arising from the rights and obligations of insurance and reinsurance contracts acquired in a business combination are recognized on the acquisition date and measured at their acquisition-date fair values. That recognition and measurement might include a reinsurance recoverable, a liability to pay future contractual claims and claim expenses on the unexpired portions of the acquired contracts, and a liability to pay incurred contractual claims and claim expenses. However, those assets acquired and liabilities assumed would not include the acquiree’s insurance and reinsurance contract accounts, such as deferred acquisition costs and unearned premiums that do not represent future cash flows.

Although insurance and reinsurance contracts are measured at fair value, the FASB noted in paragraph B192 of Statement 141(R) that an acquirer should be able to subsequently report the acquired business on the same basis as its written business. However, rights and obligations related to insurance and reinsurance contracts are not measured at fair value under existing GAAP. Thus, in ASC 944-805, the Board provided specific measurement and recognition guidance that requires an acquirer to separate the fair value of the insurance and reinsurance contracts it acquires into (1) insurance and reinsurance GAAP accounting balances, in keeping with the acquirer’s accounting policies, and (2) an intangible asset (or, infrequently, another liability) for the difference between the fair value of the insurance and reinsurance contracts and the amount recognized in accordance with the acquirer’s existing accounting policies. As a result, the acquirer is permitted to subsequently report the acquired business on the same basis as its written business since the intangible asset is amortized separately. However, while the total value of an insurance contract represents its fair value, the elements of a contract do not (i.e., the rights and obligations related to insurance and reinsurance contracts are measured under existing GAAP, and the intangible asset (or liability) is calculated as a residual).

Other contracts that provide third-party contingent commissions are accounted for in the same manner as other contingencies, and contracts that provide guarantees of the adequacy of claims liabilities are accounted for as indemnifications.

4.3.12.3 Deferred Acquisition Costs and Unearned Premiums

An acquiree’s capitalized deferred acquisition costs and unearned premiums do not meet the definition of assets and are not carried forward or recognized by the acquirer in a business combination.

4.3.12.4 Subsequent Accounting for Insurance or Reinsurance Contracts

ASC 805-20

35-7 Topic 944 on insurance provides guidance on the subsequent accounting for an insurance or reinsurance contract acquired in a business combination.

ASC 805 refers to the subsequent measurement guidance for insurance contracts in ASC 944. Under that guidance, the insurance contract intangible asset (or liability) is measured on a basis consistent with the related insurance or reinsurance liability. Specifically, ASC 944-805-35-1 through 35-3 provide the following guidance:

ASC 944-805

35-1 After the business combination, the acquirer shall measure the intangible asset (or other liability) on a basis consistent with the related insurance or reinsurance liability.

35-2 For example, for most short-duration contracts such as many property and liability insurance contracts, claim liabilities are not discounted under generally accepted accounting principles (GAAP), so amortizing the intangible asset like a discount using an interest method could be an appropriate method.

35-3 For certain long-duration contracts such as most traditional life insurance contracts, using a basis consistent with the measurement of the liability would be similar to the guidance provided in paragraph 944-30-35-3, which requires that deferred acquisition costs be amortized using methods that include the same assumptions used in estimating the liability for future policy benefits.

Pending Content (Transition Guidance: ASC 944-40-65-2)

35-3 For certain long-duration contracts such as traditional life insurance contracts, using a basis consistent with the measurement of the liability would be similar to the guidance provided in paragraph 944-30-35-3, which requires that deferred acquisition costs be amortized using methods that include assumptions consistent with those used in estimating the liability for future policy benefits including subsequent revisions to those assumptions. Also, paragraph 944-30-35-63 specifies that the present value of future profits is subject to premium deficiency testing in accordance with the provisions of Subtopic 944-60.

4.3.13 Contract Assets and Contract Liabilities — After Adoption of ASU 2021-08

Sections 4.3.13.1 through 4.3.13.4 address the accounting for contract assets and contract liabilities assumed in a business combination after the adoption of ASU 2021-08. See Section 4.11 for information about recognizing and measuring assets and liabilities associated with revenue contracts before an entity adopts ASU 2021-08.

Changing Lanes

On October 28, 2021, the FASB issued ASU 2021-08, which requires “acquiring entities to apply Topic 606 to recognize and measure contract assets and contract liabilities in a business combination.” ASU 2021-08 amends ASC 805 to add contract assets and contract liabilities to the list of exceptions to the recognition and measurement principles that apply to business combinations and to “require that an entity (acquirer) recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606.” Before the amendments, an acquirer generally recognizes such items at fair value on the acquisition date.

ASU 2021-08’s amendments are effective as follows:

For public business entities — Fiscal years beginning after December 15, 2022, including interim periods within those fiscal years.
For all other entities — Fiscal years beginning after December 15, 2023, including interim periods within those fiscal years.

The amendments should be applied prospectively to business combinations occurring on or after the effective date of the amendments.

The ASU clarifies that “[e]arly 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.” For example, assume that an entity with a calendar year-end had one business combination in the second quarter of 2020 and another business combination in the third quarter of 2021. If the entity adopts the amendments in the fourth quarter of 2021, it would apply the amendments retrospectively to the acquisition that occurred in the third quarter of 2021 but would not apply them retrospectively to the acquisition that occurred in the second quarter of 2020 even if it had not yet issued financial statements for the year ended December 31, 2020.

ASC 805-20

Pending Content (Transition Guidance: ASC 805-20-65-3)

30-27 An acquirer shall measure a contract asset or contract liability in accordance with Topic 606 on revenue from contracts with customers. This includes a contract asset or contract liability from the following:

Contracts with customers
Other contracts to which the provisions of Topic 606 apply.

30-28 An acquirer shall measure the contract assets and contract liabilities of the acquired contract as if the acquirer had originated the acquired contract. Topic 606 specifies when certain assessments and estimates should be made, for example, as of contract inception or on a recurring basis. At the acquisition date, the acquirer shall make those assessments as of the dates required by Topic 606.

30-29 An acquirer may use one or more of the following practical expedients when applying paragraphs 805-20-30-27 through 30-28 at the acquisition date:

For contracts that were modified before the acquisition date, an acquirer may reflect the aggregate effect of all modifications that occur before the acquisition date when:
1. Identifying the satisfied and unsatisfied performance obligations
2. Determining the transaction price
3. Allocating the transaction price to the satisfied and unsatisfied performance obligations.
For all contracts, for purposes of allocating the transaction price, an acquirer may determine the standalone selling price at the acquisition date (instead of the contract inception date) of each performance obligation in the contract.

30-30 For any of the practical expedients in paragraph 805-20-30-29 that an acquirer uses, the acquirer shall apply that expedient on an acquisition-by-acquisition basis. Each practical expedient that is elected shall be applied consistently to all contracts acquired in the same business combination. In addition, the acquirer shall provide the disclosures in paragraph 805-20-50-5.

ASU 2021-08 amends ASC 805 to add contract assets and contract liabilities to the list of exceptions to the recognition and measurement principles that apply to business combinations. As a result of the amendments, an acquirer will recognize and measure “contract assets and contract liabilities acquired in a business combination in accordance with Topic 606.” The amendments also clarify that entities should use the definition of a “performance obligation” in the ASC master glossary to determine whether a contract liability should be recognized in a business combination. While primarily related to contract assets and contract liabilities that were accounted for by the acquiree in accordance with ASC 606, “the amendments also apply to contract assets and contract liabilities from other contracts to which the provisions of Topic 606 apply, such as contract liabilities from the sale of nonfinancial assets within the scope of Subtopic 610-20.”

After the amendments are adopted, it is expected that an acquirer will generally recognize and measure acquired contract assets and contract liabilities in a manner consistent with how the acquiree recognized and measured them in its preacquisition financial statements. However, the Board acknowledges that:

[T]here may be circumstances in which the acquirer is unable to assess or rely on how the acquiree applied Topic 606, such as if the acquiree does not follow GAAP, if there were errors identified in the acquiree’s accounting, or if there were changes identified to conform with the acquirer’s accounting policies. In those circumstances, the acquirer should consider the terms of the acquired contracts, such as timing of payment, identify each performance obligation in the contracts, and allocate the total transaction price to each identified performance obligation on a relative standalone selling price basis as of contract inception (that is, the date the acquiree entered into the contracts) or contract modification to determine what should be recorded at the acquisition date.

We believe that another circumstance in which the acquirer would not be able to carry over the acquiree’s contract asset or contract liability amounts would be if there are differences between the acquirer’s and the acquiree’s estimates in the application of ASC 606 (e.g., the estimates of variable consideration and application of the constraint or the estimates of stand-alone selling prices or the measure of progress when revenue is recognized over time).

Therefore, the Board notes that “the amendments may not always be as simple as recording the same contract assets and contract liabilities that were recorded by the acquiree before the acquisition and that there may be additional effort required to evaluate how the acquiree applied Topic 606.” According to the FASB, ASU 2021-08 is intended “to improve the accounting for acquired revenue contracts with customers in a business combination by addressing diversity in practice and inconsistency related to the following:

Recognition of an acquired contract liability
Payment terms and their effect on subsequent revenue recognized by the acquirer.”

Since the issuance of ASC 606, questions have arisen related to both the recognition and measurement of contract assets and contract liabilities in a business combination. Specifically, stakeholders have questioned whether entities should apply the concept of a performance obligation in determining whether a contract liability should be recognized as part of an acquisition. Before the concept of a performance obligation was introduced in ASC 606, an acquirer generally only recognized an acquiree’s deferred revenue (i.e., contract liability) when the acquirer determined that the acquiree had a “legal obligation.” However, under ASC 606, a performance obligation also includes implied promises and customary business practices within contracts with customers regardless of whether such promises are legally enforceable. Therefore, a performance obligation may be broader than a legal obligation.

Before the issuance of ASU 2021-08, stakeholders had also asked the Board to provide guidance on measuring revenue contracts in a business combination. Before adoption of the amendments, assets and liabilities from revenue contracts with customers are measured at fair value under ASC 805 rather than on the basis of the principles in ASC 606. In addition, paragraph BC13 of the ASU notes that before adoption of its amendments, the timing of a customer’s payment under a revenue contract could affect the amount of revenue recognized by the acquirer in the postacquisition period:

When a revenue contract is paid upfront, an acquirer recognizes an assumed contract liability at fair value when the acquiree has received consideration from the customer and there is still a remaining unsatisfied, or partially unsatisfied, obligation as of the acquisition date. The resulting fair value measurement will often be lower than the contract liability balance that is recorded by the acquiree. Under fair value measurement techniques, the costs or activities to enter into the contract are considered to have already been performed by the acquiree before the acquisition and, therefore, are not included in the measurement of the remaining obligation for the related contract liability. However, under Topic 606, the costs to enter into the contract are not considered for purposes of revenue recognition, and contract liabilities are derecognized as the corresponding performance obligation is satisfied by transferring either a good or service to the customer. Alternatively, when a contract is paid over time as performance occurs, an acquirer likely would not analyze the specific revenue contract at the acquisition date because there would be no identifiable assets or liabilities assumed to measure at fair value for that contract (absent assumed intangible assets). Therefore, there is no contract-specific fair value adjustment, and an acquirer likely would subsequently recognize the same amount of revenue that the acquiree would have recognized if no business combination took place.

As a result of these considerations, the Board decided to amend ASC 805 to improve comparability for both the recognition and measurement of acquired revenue contracts by providing (1) guidance on “how to determine whether a contract liability is recognized by the acquirer in a business combination” and (2) “specific guidance on how to recognize and measure acquired contract assets and contract liabilities from revenue contracts in a business combination.”

The Board acknowledged that measuring contract liabilities under ASC 606 rather than at fair value under ASC 805 could result in an increase in the amounts of both the contract liability recognized and, correspondingly, the revenue the acquirer recognizes in the postacquisition period. Paragraph BC42 states, in part:

The Board acknowledged that the expected increase in contract liabilities in a business combination will result in an increase in the subsequent revenue recognized by an acquirer, which a few stakeholders equated to creating an opportunity to “buy revenue.” That is, the acquirer may be able to recognize revenue for activities performed by an acquiree before the acquisition (for example, selling and marketing efforts to enter into the contracts). This concern was included in the basis for conclusions of Statement 141(R) as support for why previous business combination accounting under the pooling-of-interests method was inappropriate. However, the comprehensive guidance in Topic 606, which was issued after Statement 141(R), limited the number of arrangements that present this opportunity. Additionally, the model in Topic 606, which requires that an entity recognize revenue as the entity satisfies performance obligations, represents a faithful representation of performance and the revenue recognized for that performance. Accordingly, satisfying a performance obligation postacquisition will result in a consistent approach to recognizing revenue that is generally not affected by the timing of payment or by whether it was originated by the acquiree or the acquirer. The Board also indicated that stakeholders understand the Topic 606 guidance and its resulting outcomes and that the amendments in this Update provide subsequent revenue information that users seek when an entity completes a business combination.

However, the Board believes that the amendments to ASU 2021-08 will:

“[I]mprove comparability for both the recognition and measurement of acquired revenue contracts with customers at the date of and after a business combination.”
“[I]mprove comparability by specifying for all acquired revenue contracts regardless of their timing of payment (1) the circumstances in which the acquirer should recognize contract assets and contract liabilities that are acquired in a business combination and (2) how to measure those contract assets and contract liabilities.”
“[I]mprove comparability after the business combination by providing consistent recognition and measurement guidance for revenue contracts with customers acquired in a business combination and revenue contracts with customers not acquired in a business combination.”

See Deloitte’s Roadmap Revenue Recognition for more information.

4.3.13.1 Practical Expedients

As discussed in paragraphs BC34 and BC35 of ASU 2021-08, to address stakeholder “concerns about the complexity of the guidance related to circumstances in which (a) the acquirer has to assess long-term, complex contracts that may have been previously modified or (b) the acquirer is unable to assess or rely on the acquiree’s accounting under Topic 606,” the Board decided to provide certain expedients. ASC 805-20-30-29 allows an acquirer to “use one or more of the following practical expedients when applying paragraphs 805-20-30-27 through 30-28 at the acquisition date:

For contracts that were modified before the acquisition date, an acquirer may reflect the aggregate effect of all modifications that occur before the acquisition date when:
1. Identifying the satisfied and unsatisfied performance obligations
2. Determining the transaction price
3. Allocating the transaction price to the satisfied and unsatisfied performance obligations.
For all contracts, for purposes of allocating the transaction price, an acquirer may determine the standalone selling price at the acquisition date (instead of the contract inception date) of each performance obligation in the contract.”

As explained in paragraph BC35 of the ASU, the first expedient “provides relief for contracts that have been previously modified before the acquisition date” by allowing an acquirer to reflect the aggregate effect of all modifications as of the acquisition date. The second expedient provides “relief for situations in which the acquirer does not have the appropriate data or expertise to analyze the historical periods in which the contract was entered into” by allowing an acquirer to determine the stand-alone selling price as of the acquisition date. Under ASC 805-20-30-30, any practical expedients used by the acquirer should be applied (1) “on an acquisition-by-acquisition basis” and (2) “consistently to all contracts acquired in the same business combination.” Entities are also required to provide certain disclosures if they elect to use any of the practical expedients. See Section 7.3.6 for more information.

4.3.13.2 Subsequent Accounting

Assets acquired and liabilities assumed in a business combination are accounted for after the acquisition date in accordance with applicable GAAP on the basis of the nature of the assets and liabilities unless ASC 805 provides specific subsequent measurement guidance. Accordingly, an acquirer should apply the appropriate GAAP (e.g., ASC 606 or ASC 610-20) to contract assets and contract liabilities acquired in a business combination after the acquisition date.

4.3.13.3 Other Assets That Arise From Revenue Contracts

ASU 2021-08 notes that the amendments “do not affect the accounting for other assets or liabilities that may arise from revenue contracts with customers in accordance with Topic 606, such as refund liabilities, or in a business combination, such as customer-related intangible assets and contract-based intangible assets. For example, if acquired revenue contracts are considered to have terms that are unfavorable or favorable relative to market terms, the acquirer should recognize a liability or asset for the off-market contract terms at the acquisition date.”

4.3.13.4 Costs of Obtaining a Contract

Before a business combination, an acquiree may have recognized an asset for the incremental costs of obtaining a contract with a customer (e.g., sales commissions) in accordance with ASC 340-40-25-1. While we do not believe that the acquirer of such an entity should recognize an asset for those costs in its postcombination financial statements, we do believe that the costs incurred to obtain a customer may be reflected in the value of another asset, such as a customer relationship intangible asset.

4.3.13.5 Up-Front Payments to Customers

ASC 606 specifies that if consideration paid to a customer is not in exchange for a distinct good or service, the consideration paid should be reflected as a reduction of the transaction price that is allocated to the performance obligations in the contract. If an up-front payment is made as part of an enforceable contract with a customer, treating that payment as a reduction of the transaction price would result in the recording of an asset for the up-front payment made, which would then be recognized as a reduction of revenue as the promised goods or services are transferred to the customer. (See Section 6.6.3 of Deloitte’s Roadmap Revenue Recognition for more information).

While we do not believe that the acquirer should recognize a separate asset for those up-front payments in its postcombination financial statements, we do believe that the up-front payments to customers could affect the value of another asset, such as a customer relationship intangible asset or an off-market component of a customer contract.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.