FASB Provides Guidance on Recognizing and Measuring Contract Assets and Contract Liabilities From Contracts With Customers Acquired in a Business Combination
Background
On October 28, 2021, the FASB issued ASU 2021-08,1 which amends ASC 8052 to “require acquiring entities to apply Topic 606 to recognize and measure
contract assets and contract liabilities in a business combination.” Under
current GAAP, an acquirer generally recognizes such items at fair value on the
acquisition date.
According to the FASB, this Update 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.”
The ASU notes that the amendments 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.”
Since the issuance of ASC 606,3 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
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. Under
current guidance, assets and liabilities from revenue contracts with customers
are generally measured at fair value under ASC 805 rather than on the basis of
the principles in ASC 606. In addition, the ASU notes that before the amendments
made by ASU 2021-08, 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.”
Key Provisions of the ASU
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.” 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.”
As a result of the amendments made by the ASU, 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.
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.”
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 practical expedients. 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. 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.”
In addition, 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.”
Effective Dates and Transition Requirements
The ASU’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 the amendments 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.
Footnotes
1
FASB Accounting Standards Update (ASU) No. 2021-08,
Accounting for Contract Assets and Contract Liabilities From
Contracts With Customers.
2
FASB Accounting Standards Codification (ASC) Topic 805,
Business Combinations.
3
FASB Accounting Standards Codification Topic 606, Revenue From
Contracts With Customers.