FASB issues proposal on acquired contracts for revenue
Published February 2, 2021
On December 15, 2020, the Financial Accounting Standards Board (FASB) issued a proposal that clarifies how companies should recognize and measure revenue-generating contracts that have been acquired in business combinations. The proposal may help eliminate accounting differences among companies’ financial reporting practices.
Currently, companies follow the fair value measurement principle in Accounting Standards Codification Topic 805, Business Combinations, for reporting acquired contracts that have a lot of upfront payments and, therefore, deferred revenue. Why does this standard cause differences in financial reporting? Current accounting rules don’t specifically address contract assets and contract liabilities arising from revenue contracts with customers and other similar contracts that are accounted for in accordance with Topic 606, Revenue from Contracts with Customers.
Under the proposal, Topic 805 would be amended so that acquired revenue-generating contracts would be recognized and measured in accordance with Topic 606. This could change the accounting approach some companies in the software and technology industry use.
A novel approach
Proposed Accounting Standards Update No. 2020-1000, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, would require a buyer (or “acquirer”) to assess, at the acquisition date, how the seller (or “acquiree”) applied Topic 606. This assessment would be used to determine what to record for the acquired revenue contracts. “Generally, this would 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 generally accepted accounting principles [GAAP]),” the proposal states.
There may be circumstances in which an acquirer would have to apply the guidance in Topic 606 to the acquired contract. For example, Topic 606 would apply if the acquiree didn’t follow GAAP. It also would be relevant if there were 1) errors identified in the acquiree’s accounting, or 2) changes identified to conform with the acquirer’s accounting policies.
The proposal primarily addresses the accounting-for-revenue contracts from customers in a business combination. But the changes would also apply to contract assets and contract liabilities from other contracts that applied the provisions of Topic 606, such as contract liabilities from the sale of nonfinancial assets within the scope of Subtopic 610-20, Other Income — Gains and Losses from the Derecognition of Nonfinancial Assets.
Two FASB members dissented to the proposal. They don’t support the proposed change in measurement basis for contract assets and contract liabilities that are acquired in a business combination.
“Such a change would create both an exception to the fair value measurement required by Topic 805 and an additional difference between GAAP and International Financial Reporting Standards related to accounting for business combinations,” the dissenters wrote.
In addition, the dissenters believe that the proposal wouldn’t improve the accounting for business combinations or provide more decision-useful information. They argue that that the expected benefits wouldn’t justify the expected costs.
The FASB is seeking public comment on the proposal by March 15, 2021. If finalized, the rules would be applied prospectively to business combinations occurring on or after the effective date of the proposed amendments.
Early adoption of the proposal would be permitted, including adoption in an interim period. Companies that adopt the rules early would apply the changes to all prior business combinations that have occurred since the beginning of the annual period that includes that interim period.