The FASB on October 28, 2021, issued a narrowly drawn standard that aims to stem reporting differences that have bubbled up among companies about how to account for revenue contracts acquired in a business combination. FASB member Christine Botosan dissented; new board member Fred Cannon abstained.
The new standard clarifies that an acquirer of a business should recognize and measure contract assets and contract liabilities in a business combination in accordance with Topic 606, Revenue from Contracts with Customers.
The change is significant to mergers and acquisitions (M&A), as it will enable an acquirer of a business to book higher revenues than current allowed, accountants have said. Moreover it will provide investors will comparable information, more useful for making investment decisions.
The rules “will align the accounting for these acquired contracts to the accounting for revenue contracts originated by the acquirer and will provide more comparable information to investors and other financial statement users seeking to better understand the financial impact of these acquisitions,” FASB Chair Richard Jones said in a statement.
The standard, issued as Accounting Standards Update (ASU) No. 2021-08, Business Combinations (Topic 805) Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, will take effect beginning after December 15, 2022, for public company fiscal-year filers, including interim periods within those years.
For all other entities, it is effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years.
To transition the guidance, companies would apply the change “prospectively to business combinations occurring on or after the effective date of the amendments,” the rule text explains.
Early adoption is permitted, including adoption in an interim period but with a caveat. An entity that early adopts in an interim period needs to apply the amendments “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 prospectively to all business combinations that occur on or after the date of initial application,” the rules state.
The guidance comes at a time when the FASB has been doing a post-implementation review (PIR) of some of its bigger standards, including Topic 606, which replaced hundreds of pieces of industry-specific guidance in 2014.
Under GAAP, an acquirer generally recognized assets acquired and liabilities assumed in a business combination, including contract assets and contract liabilities arising from revenue contracts with customers and other similar contracts that are accounted for in accordance with Topic 606 at fair value on the acquisition date.
Companies, however, found it unclear how an acquirer should evaluate whether to recognize a contract liability from a revenue contract with a customer acquired in a business combination after Topic 606 is adopted.
Moreover, some said that under current practice, the timing of payment (payment terms) of a revenue contract may subsequently affect the post-acquisition revenue recognized by the acquirer.
Botosan, the academic on the board, in a written dissent said she does not support the change in measurement basis for contract assets and contract liabilities (as defined in Topic 606) that are acquired in a business combination.
Among reasons is that the “change creates both an exception to the fair value measurement required by Topic 805 and an additional difference between generally accepted accounting principles and International Financial Reporting Standards related to accounting for business combinations,” she wrote.
Moreover, Botosan said that the update does not improve the accounting for business combinations, does not meet the objective of financial reporting of providing more decision-useful information, and the expected benefits do not justify the expected costs.
For in-depth analysis of the FASB’s revenue recognition standard, please see Catalyst: US GAAP — Revenue Recognition, also on Checkpoint.
Additional analysis of the revenue standard can be found on Checkpoint in the Accounting and Auditing Update Service and the SEC Accounting and Reporting Update Service [SARU No. 2014-21] (June 2014): Special Report: Comprehensive Coverage of the New U.S. GAAP Revenue Recognition Requirements.
An analysis of the guidance for business combinations can be found at Catalyst: US GAAP — Business Combinations, also on Checkpoint.