FASB updates guidance on acquired contracts for revenue
Published August 24, 2021
On July 28, the Financial Accounting Standards Board (FASB) approved a proposal that clarifies how companies should recognize and measure revenue-generating contracts that have been acquired in business combinations. Here’s an overview of what’s changing and how it may help eliminate accounting differences among companies’ financial reporting practices.
Need for change
Due to the lack of specific guidance under U.S. Generally Accepted Accounting Principles (GAAP), reporting differences have bubbled up among companies when it comes to accounting for revenue contracts with customers that have been acquired in a business combination. 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.
Under the approved changes, a buyer (or “acquirer”) would assess, at the acquisition date, how the seller (or “acquiree”) applied Topic 606, Revenue from Contracts with Customers. This assessment would be used to determine what to record for the acquired revenue contracts. In general, an acquirer would recognize and measure 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 GAAP.
In some situations, 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 updated rules are expected to be simpler for accountants to apply, resulting in better information for investors at a lower cost. “This is an area where we’re actually reducing costs to entities and increasing relevance to users,” said FASB Vice Chair James Kroeker.
Under the forthcoming guidance, an entity would use the definition of a “performance obligation” that’s applied in Topic 606 to determine whether to recognize a contract liability at the acquisition date. Additionally, acquired contract assets and contract liabilities would be measured in accordance with Topic 606 at the acquisition date. Therefore, the acquirer would no longer measure contract assets and contract liabilities at fair value, but instead utilize the contract transaction price in accordance with the principles of Topic 606.
In agreeing to finalize Proposed Accounting Standards Update No. 2020-1000, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, the FASB also voted:
To allow practical expedients. A practical expedient is a cost-effective way of achieving the same or a similar accounting or reporting objective. Here, practical expedients would be permitted 1) for contracts that are complex and long term, or 2) if an acquirer is unable to rely on the acquiree’s application of Topic 606. Practical expedients would be available to all acquirers, and they would be applied on an acquisition-on-acquisition or contract-by-contract basis. Additionally, entities would need to disclose practical expedients that have been used, and to the extent reasonably possible, a qualitative assessment of the estimated effect of applying each of the expedients.
To table an issue related to the current expected credit losses (CECL) model. The forthcoming rules won’t address the recognition and measurement of the associated allowance for CECL from acquired contract assets. Instead, this issue will be dealt with in another FASB project addressing CECL issues.
The FASB also agreed not to add more disclosures, other than what was originally proposed in December 2020.
The updated guidance will be issued during the fourth quarter of 2021. It will take effect for fiscal years after December 15, 2022, including interim periods within that fiscal year for public companies. For private companies, it takes effect after December 15, 2023, and interim periods within that fiscal year.
Early adoption will be permitted, including adoption in an interim period. Companies that adopt the rules early must apply the changes to all prior business combinations that have occurred since the beginning of the annual period that includes that interim period. Contact your CPA for more information.