March 12, 2021
Hillary H. Salo
Financial Accounting Standards Board
401 Merritt 7, PO Box 5116
Norwalk, CT 06856-5116
Re: File Reference No. 2020-1000
Dear Ms. Salo:
PricewaterhouseCoopers LLP appreciates the opportunity to comment on the Proposed Accounting Standards Update (the proposed Update), Business Combinations (Topic 805
): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers
. As a general matter, we believe that the accounting for a business combination should match the economics of that transaction and maximize the use of fair value of the acquired business. Additionally, we believe that the goal should be to maintain convergence between US GAAP and IFRS in this area, and limit further differences between the business combination and asset acquisition models. However, we acknowledge that financial statement preparers incur costs and encounter complexities in recognizing and measuring acquired contract assets and contract liabilities arising from revenue contracts with customers that will continue after the merger date and the FASB has indicated that its feedback from users is supportive of the proposed change.
Given this feedback, we support recognizing and measuring contract assets and contract liabilities acquired in a business combination in accordance with Topic 606
. However, we believe the recognition and measurement guidance as currently written could be clarified, as described in our responses to Questions 2, 3, and 4.
The Appendix contains our detailed responses to the Questions for Respondents.
Question 1: Should an entity be required to recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606? If not, please explain why and what alternative would be more appropriate.
We believe that exceptions to the recognition and measurement principles of Topic 805
should be limited to instances when application is overly complex and challenging. Our outreach to financial statement preparers indicated that the proposed amendments would be generally consistent with current practice for acquired revenue contracts with contract assets at the acquisition date. As it relates to contract liabilities, our outreach indicated that financial statement preparers incur additional costs to determine the fair value adjustments currently required by Topic 805
and then maintain records that adjust revenue by reversing out the effects of the fair value adjustments in order to report and explain those adjustments to users. Given this feedback, we support the proposed amendments that would require an entity to recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606
Question 2: Is the recognition guidance in the proposed amendments understandable and operable? If not, please explain why.
The recognition guidance in the proposed amendments is largely understandable and operable. However, we believe it would be helpful to bring language found only in the Basis for Conclusions into the Codification. For example, BC31 states that "while the future expected variable consideration that is constrained under Topic 606
would be precluded from being measured and recognized in the contract asset balance, the fair value of that expected variable consideration could still be captured as part of the valuation of customer-related intangible assets. The Board understands that this is similar to how revenue contracts with variable consideration are generally valued and accounted for in current practice." We have observed diversity in practice in that some reporting entities consider the fair value of the expected variable consideration to be a financial asset. Such treatment would not result in revenue as the variable consideration is received. There would also be no corresponding expense as the asset would not be amortized. We suggest that Subtopic 805-20
state that the amount recognized as a contract asset in acquisition accounting should reflect the application of the variable consideration guidance in Topic 606
applied as of the date of the business combination, and that the impact of the expected variable consideration from a fair value perspective would be recognized in customer-related intangible assets. Other examples are included in our responses to Questions 3 and 4.
Question 3: Is the measurement guidance in the proposed amendments understandable and operable? If not, please explain why.
The measurement guidance in the proposed amendments is largely understandable and operable. However, we have the following suggestions to improve the proposed amendments:
- ASC 805-20-25-28C should clarify that the acquirer should measure a contract asset or contract liability based on the original terms of the acquired revenue contract (and estimates such as relative standalone selling price of the performance obligations as of the contract inception date or latest contract modification date, if applicable).
- The language in BC28 should be incorporated into the standard to clarify that this is not a pure carryover model and the acquirer might have to adjust a contract asset or contract liability in acquisition accounting for differences in accounting policies and accounting estimates between the acquirer and acquiree, as well as for errors in accounting by the acquiree.
- The proposed Update should explicitly include refund liabilities associated with contracts with customers, computed under Topic 606, along with contract assets and contract liabilities.
- The proposed Update should clarify whether contract assets recorded in a business combination are in the scope of ASC 326-20. Topic 606 requires contract assets to be evaluated for credit losses under Subtopic 326-20. If the Board intends for contract assets recorded in a business combination to be in the scope of ASC 326-20 as part of this proposed Update, we recommend that ASC 805-20 provide clear guidance that an allowance shall be recorded on contract assets with a corresponding charge to credit loss expense as of the acquisition date (consistent with ASC 805-20-30-4A).
Question 4: The proposed amendments would not amend the existing guidance for other assets or liabilities that may arise from revenue contracts from customers in a business combination, such as customer-related intangible assets and contract-based intangible assets. Is the existing guidance on customer-related intangible assets and contract-based intangible assets, such as contracts with off-market terms, understandable and operable under the proposed amendments? If not, please explain why and what additional guidance would be necessary to make it operable.
We have the following suggestions to improve the proposed amendments related to intangible assets:
- As noted in our response to Question 2, BC31 indicates that the fair value of the expected variable consideration could still be captured as part of the valuation of customer-related intangible assets. We are concerned with diversity in practice as some reporting entities consider the fair value of the expected variable consideration to be a financial asset. Accordingly, we recommend explicitly stating the Board’s conclusions in the codified guidance to prevent diversity in practice.
- We believe that the Board should clarify in the proposed Update how an acquirer should determine the value to record as intangible assets for symbolic intellectual property and the offsetting effect of the contract liability recorded under the proposed Update for the license of such intellectual property. For example, in the case of a target company that has licensed symbolic intellectual property in a particular jurisdiction to a customer for a period of time in exchange for an upfront payment prior to the acquisition date, the acquirer would record a contract liability under the proposed amendments. The amount of the contract liability would be based on the original license fee and the remaining term of the license agreement (whereas no such contract liability would have been recorded under existing guidance). We believe that the fair value of the intangible asset for the intellectual property should consider that there will be no future cash flows associated with the licensed jurisdiction for the remainder of the license term (i.e., the fair value should be reduced for this absence of cash flows, even though there will be revenue recognized under the proposed Update). Additionally, we believe that there is no customer relationship intangible asset to record in this situation, as there are no further cash flows to be received from the customer under the license agreement subsequent to the acquisition date. This will result in revenue subsequent to the acquisition date but not a corresponding amount of amortization expense as the intangible asset for the intellectual property will not incorporate any value associated with the license. Rather, the offsetting amount associated with the contract liability for the license agreement would be recorded in goodwill.
If this reflects the Board’s intent, we recommend that the language in BC33 be updated to more clearly articulate this result. BC33 in the proposed Update states that the impact of the amendments on the determination of the contract liability balance in acquisition accounting should be recorded in goodwill. However, this paragraph describes this in the context of increases to the amount recognized for contract liabilities due to previous downward fair value adjustments associated with selling and marketing efforts that will no longer be part of the measurement of the contract liability under the proposed Update. We are concerned that preparers may not appreciate that this same approach applies to other arrangements, such as the license of symbolic intellectual property described above, and may inappropriately record the offsetting amount for the contract liability to another asset category, such as the customer relationship intangible asset described in BC31 for licenses of functional intellectual property with variable royalty payments.
- Consistent with our response to Question 3, we recommend that the proposed Update more clearly reflect the timing of when the various components of contract assets, contract liabilities, and contract-based intangible assets and liabilities should be measured (and using data as of what date). We understand that the Board’s intent is to measure the contract assets and liabilities using contract terms, determination of performance obligations, and relative standalone selling prices as of the inception date of the contract (or subsequent modification dates, if applicable); assessment of variable consideration as of the date of the business combination, in addition to consideration of performance and payments received through that date; and then a reassessment of the contract terms in relation to current market conditions as of the date of the business combination in order to determine if an asset or liability should be recognized for off-market terms. We also believe it is unclear whether the determination of off-market terms should consider only future payments on an existing contract, or also the current market price of incomplete performance obligations that have already been paid for by the customer. If the latter, this would appear to negate the expected benefit of the proposed Update. We recommend that this guidance be more clearly reflected in the final codified guidance, and not solely in the Basis for Conclusions.
- We note that in BC30, there is language about off-market contract terms which states that revenue after the acquisition may be different than what would have been recognized by the target company “if the amortization of that asset or liability is presented in revenue.” We would expect such off-market terms to be reflected as an adjustment to revenue, whereas the language in the proposed Update implies that there is either a policy election or a facts-and-circumstances assessment that could result in a different classification of such amounts. We recommend that this language be updated to require classification of this amortization as an adjustment to revenue; or explain if there are situations when classification in another account is appropriate.
Question 5: If the recognition or measurement guidance in the proposed amendments is inoperable or is overly burdensome, are there any practical expedients that should be considered?
We do not believe that practical expedients are necessary. However, if the acquired company has not previously adopted the provisions of Topic 606
, we believe that the practical expedients provided in ASC 606-10-65-1
should be available in order to determine the appropriate balances as of the date of acquisition.
Question 6: Would the proposed amendments result in financial reporting outcomes that are appropriate and meaningful for users of financial statements? Please explain why or why not.
We believe that the fair value recognition and measurement principles of Topic 805
produce the most appropriate and meaningful outcomes. The accounting for an acquisition provides the most useful information when it matches the economics of an acquisition and the factors that were incorporated in the determination of the purchase consideration. However, we understand that diversity exists in current practice for determining the fair value of contract liabilities for certain revenue arrangements, that fair value adjustments related to contract liabilities are often difficult for users to understand, and that the effects of the fair value adjustments on the contract liability balance are typically short-lived. Additionally, as noted in our response to Question 1, financial statement preparers incur significant costs to determine the fair value adjustments and then maintain records that adjust revenue by reversing out the effects of the fair value adjustments in order to report and explain those adjustments to users. The proposed amendments address those issues while increasing comparability between revenue recognized in the preacquisition and postacquisition periods for identical contracts. As a result, we believe the proposed amendments address the challenges that preparers face without significantly impacting the usefulness of the information for users of financial statements.
Question 7: The scope of the proposed amendments would include contract assets and contract liabilities from other contracts that apply the provisions of Topic 606, such as contract liabilities from the sale of nonfinancial assets within the scope of Subtopic 610-20. Should the proposed amendments be applied to contracts beyond contracts with customers that also are accounted for in accordance with Topic 606? If not, please explain why.
We do not support including contract assets and contract liabilities from other contracts that apply the provisions of Topic 606
(either directly or by analogy) in the scope of the proposed amendments. We view the guidance in the proposed Update as an appropriate simplification for recurring customer transactions that have given rise to complexity and diversity in financial reporting. Contracts that are accounted for in accordance with or by reference to Topic 606
, such as arrangements subject to Subtopic 610-20
for the sale of nonfinancial assets or Topic 808
on collaboration agreements, are less frequent, and by definition would not impact the amount of revenue recognized from customers in the post-merger period, the alignment of which is a stated goal of the proposed Update. Additionally, certain other literature that references Topic 606
is already addressed in Topic 805
. For example, ASC 842-10-15-38
through 15-42 requires preparers to follow certain guidance in ASC 606
, but Topic 805
already addresses the appropriate accounting for leases in acquisition accounting. Including other contracts in the scope of the proposed amendments would provide limited relief to financial statement preparers while potentially introducing unintended consequences or conflicts with other accounting guidance. Accordingly, we recommend limiting the scope of the proposed Update to contracts accounted for in accordance with Topic 606
Question 8: The proposed amendments would require no incremental disclosures. Should other disclosures be required; for example, are additional disclosures needed that would provide investors with the information necessary to distinguish between acquired revenue contracts and originated revenue contracts? If yes, please explain why and provide the additional disclosures that should be required.
We do not believe that incremental disclosures are necessary, as the required disclosures within Topic 805
and Topic 606
provide sufficient information for users of financial statements. The existing guidance requires the disclosure of information that was used to recognize and measure acquired contract assets and contract liabilities, consistent with the guidance in ASC 805-20-50-1(c)
, as well as the significant changes in the contract assets and contract liabilities balances due to business combinations, as required by ASC 606-10-50-10(a)
Question 9: Should the proposed amendments be applied on a prospective basis? If not, what transition method would be more appropriate and why?
We agree that the proposed amendments should be applied on a prospective basis.
We do not support requiring or providing for optional retrospective application of the proposed amendments as allowing for adoption as of different dates would create inconsistencies between entities that could significantly affect the amount of revenue recognized from acquired businesses. We do not believe that this would benefit financial statements users. Further, retrospective application would include adjustments to goodwill and other intangible assets, and their subsequent impairment considerations, which could be costly and largely eliminate the benefit of lower costs for financial statement preparers.
Question 10: How much time would be needed to implement the proposed amendments? Should entities other than public business entities be provided with an additional year to implement the proposed amendments? Please explain why or why not.
We believe that questions regarding the time period required for implementation are better addressed by preparers. However, we do not anticipate that implementation of the new guidance would require significant incremental time, other than perhaps for acquisitions of target companies that have not adopted Topic 606
Question 11: Is the early application requirement appropriate as proposed, or should an entity not be required to apply the proposed amendments to all prior business combinations that occurred since the beginning of the annual period if the proposed amendments are applied in an interim period? Please explain why or why not.
The early application requirement is appropriate as proposed because we do not believe it is meaningful for business combinations completed at different times within the same annual period to have inconsistent accounting.
Question 12: IFRS Standards on business combinations contain guidance similar to what is currently in Topic 805. The proposed amendments would create a difference between IFRS Standards and Topic 805 for measuring contract assets and contract liabilities acquired in a business combination. Would differences in that area of the guidance create additional costs or complexity for entities or users of financial statements? Please explain why or why not.
We encourage the Board to work collaboratively with the IASB to reduce the possibility of divergence in the measurement of contract assets and contract liabilities acquired in a business combination. We believe that the quality and comparability of financial reporting is enhanced when converged acquisition accounting standards are maintained. Given the global nature of mergers and acquisition activity, consistent guidance provides an equal playing field for global stakeholders to make decisions and, therefore, maximizes the efficiency of the allocation of global capital. Different guidance, especially related to the amount of post-merger revenue recognized for otherwise identical transactions under the different standards, creates complexities for users to analyze and compare. It could also impact the amount of consideration that different entities would be willing to pay to acquire a business.