Summary of Recent FASB Proposed Accounting Standard Updates

In December 2020, the FASB issued proposed accounting standard updates related to the measurement of deferred revenue in a business combination and a private company accounting alternative for evaluating goodwill triggering events. Both proposed standards could have a significant impact on the financial statements of entities that have goodwill and/or have an acquisition accounted for as a business combination.

Measurement of Deferred Revenue in a Business Combination
The proposed ASU would provide an exception to the fair value measurement principles in ASC Topic 805, Business Combinations, which requires substantially all acquired assets and liabilities accounted for as a business combination to be measured at fair value. The exception would require all acquired contract assets and contract liabilities (deferred revenue), as defined in ASC Topic 606, to be measured in accordance with the new revenue recognition standard, ASC Topic 606, Revenue from Contracts with Customers.

Under current GAAP, deferred revenue that is acquired as part of a business combination is measured at fair value. The fair value measurement commonly results in a reduction or “haircut” in the amount of deferred revenue that was previously recorded by the acquiree. A Journal of Accountancy article published in April 2016 aptly named this fair value reduction to deferred revenue as “disappearing revenue.” The haircut can have real impacts outside of financial reporting. Debt agreements (including the terms of future covenants), contingent purchase price formulas, bonus agreements, and other items may have been negotiated and executed without taking into account the impact of a haircut to deferred revenue and the resulting future disappearing revenue.

Under the proposed ASU, all acquired contract assets and liabilities would be measured based on applying Topic 606’s five-step revenue model to each acquired contract (applied from contract inception) to determine if a contract asset or liability needs to be recognized as of the acquisition date. If a contract asset or liability is identified, it should be measured in accordance with the measurement criteria under Topic 606. It is expected that this measurement approach will increase the amount of deferred revenue recorded by an acquirer and corresponding post-acquisition revenue.

The proposed ASU would be applicable to all entities (private and public) and would be adopted prospectively for business combinations after the effective date (yet to be determined). Early adoption of the proposed amendments would be permitted. Public comments on the proposed ASU are due back to the FASB on March 15, 2021.

Private Company Accounting Alternative for Evaluating Goodwill Triggering Events
The proposed ASU was issued in December 2020 and in February 2021 the FASB met and agreed to issue a final ASU that will provide private companies with an accounting alternative for evaluating goodwill triggering events.

Under the current guidance in Topic 350-20, an entity is required to evaluate goodwill impairment triggering events throughout the fiscal year. When it is determined that a triggering event occurs, a more likely than not analysis must be performed to determine whether the fair value of a reporting unit (or entity, if elected as part of the accounting alternative for amortizing goodwill) is less than its carrying value. If it is determined that it is more likely than not that goodwill is impaired, then goodwill must be tested for impairment by comparing the fair value of the reporting unit (or entity) to its carrying value as of the date of the triggering event. In practice, this guidance has been difficult to apply as it is often difficult to determine precisely when a triggering event has occurred, and certain entities (primarily smaller private companies) may only have complete and reliable financial information available as part of its year end reporting process.

The proposed ASU, as approved, provides an accounting alternative allowing private companies and not-for-profits to perform the goodwill impairment triggering event assessment at the reporting date any time they report financial information, including interim reports. It is important to note that the FASB indicated that the final ASU will reference ASC 270, Interim Reporting, for purposes of determining what constitutes interim financial information prepared in accordance with GAAP. ASC 270 indicates that interim financial information includes summarized financial information in addition to a complete set of financial statements and footnotes. The decision by the FASB to reference ASC 270 significantly limits the benefits of the proposed alternative as many private companies issue interim financial information for many reasons (e.g. monthly or quarterly GAAP financial information submitted to a bank as required under a debt agreement, regulatory requirements, etc.) and therefore those entities will be required to evaluate goodwill for triggering events at each of those interim dates. Entities that will experience the biggest benefit from the proposed alternative are those that only issue annual financial information, thereby only having to evaluate goodwill for triggering events at the year end reporting date.

The proposed ASU would only be applicable to private and not-for-profit entities and would be adopted prospectively to financial statements with fiscal years beginning after December 15, 2019. Early adoption of the proposed amendments would be permitted in annual financial statements that have not been issued or made available for issuance at the point in time the final ASU is issued. There will be an unconditional one-time election that permits election of the alternative without having to assess “preferability” under ASC 250, Accounting Changes and Error Corrections.

Please contact a member of your Boulay client service team or contact us at 952.893.9320 or learnmore@BoulayGroup.com for more information on either of the proposed ASUs referenced above.