In short: ASU 2021-08 discusses how to properly account for deferred revenue in a business combination and affects certain businesses that acquire an entity.
In late 2021, the Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, which clarifies how to properly account for deferred revenue in a business combination. Below are frequently asked questions to consider how this new accounting standard may impact your business.
Why Did the FASB Issue ASU 2021-08?
As a means of improving the accounting for acquired revenue contracts with customers in a business combination, this ASU seeks to address diversity in practice and provide consistency surrounding:
- Recognition of an acquired contract liability (in this article, referencing deferred revenue)
- Payment terms and subsequent revenue recognition by the acquirer.
Following the implementation of ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (also, ASC 606), much debate surrounded the concept of a performance obligation and how a contract liability should be recognized in a business combination.
As the acquisition environment in the software industry has ramped up in recent years, users of the financial statements desire comparability and this often required management to provide investors and creditors with financial statements that weren’t compliant with U.S. GAAP.
Thus, ASU 2021-08 helps to align the public interest by providing guidance around the consistency in which businesses should approach these types of scenarios.
Is My Company Affected by ASU 2021-08?
Businesses that acquire an entity; and therefore, are subject to Topic 805, Business Combinations (also, ASC 805), should consider the provisions under ASU 2021-08 to consider if their financial statements will be impacted. This standard is most often seen in acquiree’s that have (or should have under U.S. GAAP) contract liabilities in their pre-acquisition financial statements as a result of their revenue contracts with customers.
What Are the Main Changes Under ASU 2021-08?
Acquirers will be required to recognize contract assets and contract liabilities acquired in a business combination in accordance with ASC 606, not ASC 805. In so doing, the acquirer should account for revenue contracts as if they had originated the contract. Generally, this should result in an acquirer recognizing and measuring the acquired contract assets and contract liabilities consistent with how they were recognized and measured in the acquiree’s financial statements (if the acquiree prepared financial statements in accordance with U.S. GAAP). If the acquiree has been applying ASC 606 and has used a performance obligation approach, the acquirer would have the ability to maintain the contract liability balance as on the acquiree’s pre-acquisition financial statements, and would be able to recognize the revenue as previously deferred if the related requirements are met. If, however, the acquiree were not previously applying ASC 606, upon acquisition, the acquirer would effectively be adopting ASC 606 for the first time.
How Does ASU 2021-08 Differ From the Previous Accounting Standard?
Previously, business combinations and the accompanying revenue contracts (and related deferred revenue) were subject to ASC 805. As acquiring entities are to revalue the acquired assets and liabilities at their fair value on the acquisition date, the fair value of deferred revenue is typically determined by computing an amount equal to the cost of providing the service plus a reasonable profit margin. This typically results in a ‘haircut’ (or write-down) adjustment as a means to normalize margin and given the costs would have already been recognized on the acquiree’s books. As this exercise will no longer be necessary once ASU 2021-08 is implemented, entities will be able to better assess performance of acquirees in the acquirer’s post-acquisition financial statements.
What is the Effective Date for ASU 2021-08?
This amendment will be effective for public entities with fiscal years beginning after December 15, 2022, and for all other entities with fiscal years beginning after December 15, 2023, with early adoption permitted. The amendments should be applied prospectively to business combinations occurring on or after the effective date of the amendment.