Improving consistency in accounting for contract assets and contract liabilities in a business combination (Update to Topic 805)

In late 2021, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2021-08 (ASU 2021-08), “Accounting for contract assets and contract liabilities from contracts with customers,” which requires that an acquirer recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606, “Revenue from Contracts with Customers.”

According to ASU 2021-08, “At the acquisition date, an acquirer should account for the related revenue contracts in accordance with Topic 606 as if it had originated the contracts.” If the acquiree had previously adopted Topic 606, the acquirer should assess the acquiree’s accounting treatment of Topic 606, which should generally result in the acquirer recognizing the acquired contract assets and contract liabilities consistent with the acquiree’s financial statements.

ASU 2021-08 offers two practical expedients to ease its application. For contracts that were modified prior to the acquisition date, the acquirer may elect to aggregate the effect of all modifications that occurred prior to the acquisition when identifying the performance obligations, determining the transaction price, and allocating the transaction price. In addition, when allocating the transaction price, the acquirer may elect to determine the stand-alone selling prices at the acquisition date rather than the contract inception date. The available practical expedients should be applied on an acquisition-by-acquisition basis and consistently applied for all contracts included in the same acquisition, as stated in the ASU.

ASU 2021-08 is effective for public business entities for fiscal years beginning after Dec. 15, 2022, including interim periods within those fiscal years; for all other entities, for fiscal years beginning after Dec. 15, 2023, including interim periods within those fiscal years. The guidance should be applied prospectively to business combinations occurring on or after the effective date, the ASU states, and early adoption is permitted.

ASU 2021-08 is intended to 1) eliminate diversity in practice when accounting for contract assets and contract liabilities in a business combination and 2) improve comparability for consistent recognition of revenue contracts that were acquired in a business combination with those that were not. It should be noted that the ASU states that the guidance does not affect the accounting for other assets and liabilities that may arise from revenue contracts as it relates to Topic 606, such as customer-related intangible assets. 

Acquirers will need to carefully consider this new guidance in relation to their accounting practices. For example, if the acquiree adopted Topic 606 prior to the business combination, then the acquirer should assess the application of Topic 606 in the acquiree’s historical financial statements and consider if it aligns with its own revenue recognition policies. In addition, an acquirer should take note that this ASU also applies to the recognition and measurement of contract assets and contract liabilities acquired in a business combination that relate to contracts with non-customers for which the provisions of Topic 606 apply.      

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Claudia Bassett, CPA, Director, National Assurance

818.205.2614

Monica Peborde, Senior Manager, National Assurance

646.254.7422