A recently issued Accounting Standards Update (ASU) will change how acquired contract assets and liabilities are recognized after a business combination. The Financial Accounting Standards Board released (FASB) ASU 2021-08 in October. It will require such items be recognized and measured based on the revenue recognition criteria established in Accounting Standards Codification (ASC) Topic 606.
Under existing Generally Accepted Accounting Principles (GAAP), these assets and liabilities would commonly be recognized at fair value on the date of acquisition. Topic 606 requires the acquirer to do the following:
- Identify the contract with a customer.
- Identify the performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price.
- Recognize revenue when or as the performance obligation is met.
In essence, the acquirer is to account for such acquisitions as if it had originated the contracts. Assuming the acquiree’s financial statements are prepared in accordance with GAAP, it is expected that the acquirer will measure and recognize the acquired contract assets and liabilities consistent with the way items were presented in the acquiree’s financial statements prior to acquisition. Although this process seems pretty straightforward, the acquirer must assess the acquiree’s application of Topic 606. There may be circumstances in which the acquiree’s accounting cannot be relied on—the financial statements were not prepared on a GAAP basis, the assessment identified errors, or the acquiree’s accounting policies and Topic 606 practical expedients are not consistent with the acquiree’s policies, for example.
When the acquirer is unable to rely on the acquiree’s application of Topic 606, the ASU indicates 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.”
The standard is effective for public business entities for fiscal years and interim periods within those fiscal years, beginning after December 15, 2022. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. The amendments in this Update should be applied prospectively to business combinations occurring on or after the effective date of the amendments.
Early adoption of the amendments is permitted, including adoption in an interim period. If an entity early adopts in an interim period, any adjustments should be reflected 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.
If you have questions about contract assets and liabilities acquired in a business combination, or if you would like assistance with any matter involving audit and assurance, business advisory, or regulatory compliance, one of our executive contacts would be happy to assist. You may email them below, or call (800) 270-9629.