In October 2021, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2021-08 Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers. The purpose of the update was to improve the accounting for acquired revenue contracts with customers in a business combination by addressing diversity in practice and inconsistency related to recognition of an acquired contract liability, as well as payment terms and their effect on subsequent revenue recognized by the acquirer.
Under current Generally Accepted Accounting Principles (GAAP) an entity that acquires contract assets and/or contract liabilities in a business combination would generally recognize the contract assets and contract liabilities at fair value on the acquisition date under ASC 805. Additionally, ASC 606 introduced the concept of performance obligations, which has resulted in a divergence in practice in regards to the recognition of deferred revenue in business combinations.
This ASU eliminates divergence in practice and improves comparability for the recognition and measurement of acquired revenue contracts with customers at initial and subsequent measurement. The ASU clarifies when an acquirer should recognize contract assets and contract liabilities in a business combination, and how the contract assets and contract liabilities should be measured and subsequently accounted for. This ASU does not apply to intangible assets related to a customer or other contract assets recognized in connection with a business combination.
In applying ASU 2021-08, the acquirer in a business combination should measure contract assets and contract liabilities on the date of acquisition as if the acquirer had originally entered into the acquired contract accounted for under ASC 606. A contract asset is recognized in the acquisition if the acquiree has transferred goods or services but not received payment because the consideration is conditional. A contract liability is recognized in the acquisition if the acquiree has received consideration from the customer but has an unsatisfied performance obligation. These requirements clarify the treatment of deferred revenues, which in practice were often only recognized as a contract liability in the purchase accounting if there were remaining legal obligations to provide a good or service. Subsequent accounting for the acquired contract assets and contract liabilities will follow the accounting under ASC 606.
ASU 2021-08 allows entities to apply the following two practical expedients, which must be disclosed in the footnotes to the financial statements along with a qualitative assessment of the effects of applying the practical expedients:
- The acquirer may reflect the aggregate of all pre acquisition modifications as of the acquisition date when identifying performance obligations, determining the transaction price, and in allocating the transaction price to the performance obligations.
- For purposes of allocating the transaction price to performance obligations, the acquirer may determine the selling price at the acquisition date rather than contract inception if the entity does not have sufficient data or otherwise lacks the ability to determine how it should have been recognized if ASC 606 was properly applied prior to the acquisition.
ASU 2021-08 is effective for public entities for fiscal years beginning after December 15, 2022 including interim periods within those years. For all other entities, ASU 2021-08 is effective for fiscal years beginning after December 15, 2023. Early adoption is permitted. While this ASU should be applied prospectively to business combinations, an entity that adopts ASU 2021-08 early in an interim period is required to apply the ASU to all business combinations that occurred during the fiscal year that includes the interim period.
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