The following example demonstrates how the guidance in ASU 2021-08 can significantly affect the accounting for acquired contract assets and contract liabilities.
Example 2: Recognized contract liabilities under ASU 2021-08
Consider the same facts as in Example 1, except that Acquirer has adopted ASU 2021-08 and, therefore, recognizes the acquired contract assets and contract liabilities using measurement principles in Topic 606 rather than at fair value.
In this scenario, on the acquisition date, Acquirer recognizes a contract liability for its remaining performance obligation to Customer X in the amount of $3 million (or $1 million per year with three years remaining) – that is, in an amount equal to the deferred revenue balance recognized by Target pre-acquisition. Subsequent to the acquisition, Acquirer recognizes into earnings the $3 million deferred revenue balance over the remaining license.
In this example, as a result of measuring contract assets and contract liabilities under measurement principles in Topic 606 instead of at fair value, Acquirer is recognizing $2.8 million more in revenue over the remaining license term. That is, Target’s pre- and post-combination revenues are preserved.
Practical considerations
While the basis for conclusions in ASU 2021-08 suggests the new measurement guidance generally will result in an acquirer recognizing contract assets and contract liabilities at amounts consistent with those recorded by the acquiree immediately prior to the acquisition, in certain scenarios this might not be the case. For example, the amounts recognized by the acquirer may differ in these situations:
- The acquirer and the acquiree have elected different revenue recognition policies and the acquirer has decided to conform the acquiree’s policy to its own (for example, a change to the measure of progress used for certain types of performance obligations).
- The acquirer determines that an adjustment is needed to previously recorded amounts due to a change in estimate (for example, a change in the measurement of variable consideration).
- The acquirer identifies an error in the acquiree’s accounting.
- The acquiree does not prepare financial statements in accordance with U.S. GAAP.
In all cases, the acquirer will need to evaluate how the acquiree applied Topic 606 to determine if adjustments to recorded amounts are needed. As part of that evaluation, the acquirer must ensure the acquiree’s measurements have been updated through the acquisition date. For example, if revenue is recognized over time, the acquirer should ensure the measure of progress reflects facts and circumstances as of the acquisition date (including costs incurred to date and estimated costs to complete).
Other changes
In addition to changing the measurement guidance for acquired contract assets and contract liabilities, ASU 2021-08 also clarifies that an acquirer must use the concept of a “performance obligation” as defined in Topic 606 to determine whether a contract liability should be recognized in a business combination from a revenue contract. Under legacy guidance, some acquirers used a “legal obligation” lens to determine which contract liabilities should be recognized in a business combination. The practical effect of the change in ASU 2021-08 is that some entities may end up recognizing more contract liabilities than previously recognized under legacy guidance because the definition of a performance obligation is broader than that of a legal obligation.
Effective date and transition
ASU 2021-08 applies prospectively to all business combinations that occur on or after the ASU’s effective date. For public business entities, the ASU is effective for fiscal years beginning after Dec. 15, 2022, including interim periods within those fiscal years. For all other entities, the ASU is effective for fiscal years beginning after Dec. 15, 2023, including interim periods within those fiscal years.
ASU 2021-08 also permits early adoption, even in a reporting period in which no business combination has occurred. If a reporting entity elects to early adopt the standard, the ASU’s provisions must be applied to all business combinations that occur in the fiscal year of adoption. For example, if an entity elects to early adopt the ASU in the fourth quarter of 2021, the ASU’s provisions must be applied retrospectively to all business combinations that occurred on or after the beginning of fiscal year 2021.