New Guidance on ASC 606 for Business Combinations

Many Atlanta businesses have already started the process of complying with the new ASC 606 Revenue Recognition standard. Originally scheduled to become effective earlier, the Financial Accounting Standards Board (FASB) voted to delay the implementation one year due to the COVID pandemic. As the implementation deadline approaches many businesses are working through the steps of examining contracts to identify where revenue recognition changes may need to be made. While there has been extensive guidance and information made available on how to identify, assess, and report revenue recognition changes, including the 5-step process, fewer details are available on how to account for revenue-generating contracts in a business combination.

Recently, FASB issued Update 2021-08 which includes two new Accounting Standard Updates (ASUs) to provide clarity on how to account for revenue-generating contracts in an acquisition. The key issues include whether a performance obligation under ASC 606 should be used to recognize a contract liability and what to do when the payment timing affects post-acquisition revenue. To help clients, prospects, and others Wilson Lewis has provided a summary of the key details below.

Current GAAP Rules

Under Generally Accepted Accounting Principles (GAAP), fair value is given to assets and liabilities on the date the business is acquired. This includes assets and liabilities in revenue-generating contracts with customers. Under Topic 606, revenue recognition, the way that revenue-generating contracts are accounted for in the financial statements is changing. For many private entities, it already has.

Topic 606 is at odds with current GAAP practices. The difference between current practice and soon-to-be required accounting standards would mean the post-acquisition revenue could be affected due to the timing of payment terms within revenue contracts. This could happen if a revenue contract is paid overtime after the acquisition, as a performance obligation occurs. When this happens, the deferred revenues of the acquired company are typically reduced in post-acquisition financial statements.

FASB’s updated guidance will require entities to apply the new standard to recognize and measure revenue contract assets and liabilities. It would be as if the acquiring entity had originated the contracts itself in accordance with Topic 606. This could also result in acquiring companies to book higher revenues than what are currently allowed, depending on the situation.

Doing so will provide a more consistent approach to revenue recognition regardless of payment timing within a revenue contract. Post-acquisition revenue would not be altered and would also be comparable for revenue contracts with customers on the date of and after the acquisition.

The remaining contract obligations wouldn’t matter for the sake of accounting because the contract is not measured at fair value as of a certain date; rather, each performance obligation is assigned a relative transaction price as of the acquisition date.

Performance Obligations Explained

Identifying specific performance obligations is a required step within the five-step framework of Topic 606. And under the newly released guidance, each performance obligation must have its own relative transaction price.

Under Topic 606, a performance obligation is a promise to transfer goods or services to a customer.  Goods or services must be distinct or a collection of distinct goods or services. These benefit the customer individually or when combined with other resources at the customer’s disposal. Examples of performance obligations vary from one industry to another. This is a representative list that does not encompass all possible obligations.

• Completion of contractually obligated tasks or milestones, as in construction
• The sale or resale of goods, as in manufacturing or retail
• Ticket sales
• Software updates
• License to goods, services, or intangible assets

In More Detail

In applying Topic 606 to revenue contracts in an acquisition, the acquirer will need to assess how the originating entity applied the new revenue recognition standards on revenue contracts – if at all. The acquirer will need to determine what to record as of the acquisition date, so the entire contract is in line with the new standards.

When it’s unclear if or whether the original entity applied Topic 606 to the contract, the acquirer should follow these steps:

• Consider the contract’s payment terms and timing,
• Identify each performance obligation, and
• For each separate performance obligation, assign a total transaction price on a stand-alone basis as of the acquisition date or a contract modification.

Accounting for other assets or liabilities that could arise from revenue contracts, like intangible assets or refund liabilities, wouldn’t be affected. For example, incremental costs like sales-based royalties.

The acquiring entity would need to determine if a contract liability should be recognized, however. Contract liabilities should be recognized if the originating entity was paid for goods or services promised in the contract but had not yet transferred control to the customer.

Implementation Dates

The new guidance on business combinations with a revenue contract will take effect for fiscal years after December 15, 2022, including interim periods, for public entities. Guidance for all other entities will take effect one year later. Early adoption is permitted. Acquisitions that are expected to close after the implementation date should apply the new standards to revenue contracts even if calculations are performed before the standards take effect.

For entities that choose early adoption during an interim period, they must apply the new standards to any business combination that occurs within the interim period as well as any transactions that take place after the standards are in place.

Contact Us

The new guidance issued by FASB provides important guidance that many Atlanta businesses need to follow to comply with the new revenue recognition standard. If you have questions about the information outlined above or need assistance with another revenue recognition issue, Wilson Lewis can help. For additional information call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.