While ASC 606 Revenue from Contracts with Customers (ASC 606) has been effective for all companies with annual reporting periods beginning after December 15, 2019, the FASB’s post-implementation review (PIR) process and updates to other standards continue to cause changes to US GAAP revenue accounting.
Most recently the FASB issued Accounting Standards Update (ASU) 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers (ASU 2021-08). The purpose of ASC 2021-08 is to address and provide clarity for how an acquirer should recognize and measure revenue contracts acquired as part of a business combination.
With ASC 606 came a precise methodology for accounting for revenue. However, as ASC 606 was put into practice, questions about its effect on other standards started to appear. ASC 805 Business Combinations provides accounting guidance for mergers and acquisitions, specifically recognizing and measuring the assets and liabilities acquired. Current guidance requires the acquirer to recognize the contract assets and liabilities acquired in a business combination at their fair value at the date of acquisition.
Further guidance provided by EITF 01-3 Accounting in a Business Combination for Deferred Revenue of an Acquiree required that deferred revenue be recognized only if the acquirer determined they had a legal obligation to transfer goods or services under a revenue contract. The liability for deferred revenue was generally recognized in the acquirer’s financial statements if it represented a legal obligation.
In contrast, ASC 606 provides for recognition of revenue based on a performance obligation. As companies transitioned to ASC 606 confusion occurred over which concept to apply to deferred revenue obligations. Some companies began applying the concept of performance obligation introduced in ASC 606 to these contracts, while others continued with the guidance in ASC 805 to apply the concept of a legal obligation before recognizing.
Additionally, stakeholders communicated that ASC 805 allowed for the timing of the payment terms of a revenue contract to affect the amount of revenue recognized by the acquirer after acquisition.
To address the inconsistencies related to the recognition and the measurement of a contract liability acquired in a business combination the FASB issued ASU 2021-8 in October of 2021. The ASU is effective for public entities with fiscal years beginning after December 15, 2022 and for non-public business entities with fiscal years beginning after December 15, 2023. Early adoption is permitted.
ASU 2021-8 specifies that revenue contracts acquired in a business combination be recognized according to the accounting guidelines provided by ASC 606, based upon whether a performance obligation has been fulfilled. Additionally, the acquirer may determine the stand-alone selling price of a revenue contract for each performance obligation at the acquisition date, rather than at the contract inception date, when allocating the transaction price among performance obligations.
To offer some relief for the adoption of ASC 2021-8, the FASB allows acquirers to apply certain practical expedients consistently to all of the contracts acquired in a single business combination:
- Contracts modified before the acquisition date, the acquirer may reflect the combined impact of all the modifications occurring prior to the acquisition date under certain circumstances and
- The acquirer may determine the standalone selling price at acquisition for the purpose of allocating the transaction price
Due to the long gap between public and non-public entities’ adoption of ASC 606, some of the PIR activities are being approached separately. ASU 2021-8 specifies ASC 606 as the accounting methodology to use for the recognition and measurement of revenue contracts acquired in a business combination and offers some practical expedients to ease adoption. This update is a result of stage two post-effective-date evaluation for public companies and we can expect to see additional stage two activities as adoption is completed for non-public entities and the review process begins.