Accounting for Contract Assets and Contract Liabilities
Accounting for business combinations is fascinating to me because there are so many considerations and nuisances included within the requirements of ASC 805. So for this post, I wanted to cover the area of contract assets and liabilities. If you are also fascinated by the accounting for business combinations, check out our Business Combinations topic page for more information and resources!
Contract assets and liabilities: What are they?
Under ASC 805, “contract assets” and “contract liabilities” refer to the rights to receive or obligations to deliver goods or services under customer contracts acquired in a business combination. They are defined under ASC 805 as:
- Contract assets: A company’s right to consideration in exchange for goods or services that the company has transferred to a customer when that right is conditioned on something other than the passage of time (e.g., the company’s future performance)
- Contract liabilities: A company’s obligation to transfer goods or services to a customer for which the company has received consideration (or the amount is due) from the customer
Note that contract liabilities are typically referred to as “deferred revenue” or “unearned revenue” because deferred revenue typically represents a performance obligation to provide a product or service in the future for which payment has already been made.
Contract assets and contract liabilities are essentially the balance sheet holding account for revenue recognition under ASC 606. For example, if a company pays money for contract costs that are capitalized, they would record the following entry:
Dr. Contract assets
Cr. Cash
Conversely, if a company receives an upfront payment for a revenue contract, but has yet to complete the work, they would record the following entry:
Dr. Cash
Cr. Contract liabilities
Accounting for contract assets and liabilities
Under ASC 805, an acquirer generally recognizes identifiable assets acquired and liabilities assumed in a business combination and measures them at fair value, with certain exceptions. Refer to our ASC 805 overview course for more information on the general accounting requirements for business combinations.
As you probably guessed, contract assets and liabilities are one of the exceptions to fair value measurement.
Contract assets and contract liabilities acquired in a business combination are required to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606 (not ASC 805!). The intent here is that the acquirer is assuming it has entered into the original contract at the same date and is using the same contract terms as the acquiree.
So, instead of determining the fair value of acquired deferred revenue, companies would need to evaluate the acquiree’s historical accounting and make any necessary adjustments for differences in the acquirer’s and acquiree’s accounting policies. In addition, companies would need to evaluate differences in estimates made by the acquirer as compared to the acquiree, or errors in the acquiree’s accounting.
It is important to note that this requirement should not be applied as just a “carryover” basis of the acquiree’s contract balances (e.g., the acquirer must assess the reasonableness of ASC 606 by the acquiree).
Scope
This guidance applies to contract assets and contract liabilities acquired in a business combination (i.e., in the scope of ASC 805) and to other contracts that directly (or indirectly) apply the requirements of ASC 606 (e.g., ASC 610-20, Other Income–Gains and Losses from the Derecognition of Nonfinancial Assets, ASC 808, Collaborative Arrangements).
Note that this guidance does not impact items such as refund liabilities, assets related to upfront payments, or costs to obtain/fulfill a contract (ASC 340-40).
Other exceptions
The accounting requirements for contract assets and liabilities create an exception to both the general recognition and measurement principles of ASC 805. As a reminder, other exceptions to both the recognition and measurement principles of ASC 805 also relate to:
- Certain assets and liabilities arising from contingencies
- Employee benefits
- Indemnification assets
- Deferred tax assets and liabilities
- Leases
In these areas, the acquirer must apply specified U.S. GAAP or specified requirements rather than the overall recognition and measurement principles to determine when to recognize and how to measure the assets or liabilities acquired. We discuss these various areas in more detail within our ASC 805 Advanced Issues course.
Final thoughts
Both the accounting for business combinations (ASC 805) and revenue recognition (ASC 606) can be complex in terms of knowing the various requirements. Hopefully this post provided helpful reminders on the accounting for contract assets and liabilities.
To ensure you have a grasp on the various requirements, we offer a 3-course collection on ASC 805 and a 7-course collection on ASC 606 in our U.S. GAAP eLearning library. Let us know if you have any other questions or would like to see another area covered under ASC 805 (or ASC 606)!
About GAAP Dynamics
We’re a DIFFERENT type of accounting training firm. We view training as an opportunity to empower professionals to make informed decisions at the right time. Whether it’s U.S. GAAP, IFRS, or audit training, we’ve trained thousands of professionals since 2001, including at some of the world’s largest firms. Our promise: Accurate, relevant, engaging, and fun training. Want to know how GAAP Dynamics can help you? Let’s talk!
Disclaimer
This post is for informational purposes only and should not be relied upon as official accounting guidance. While we’ve ensured accuracy as of the publishing date, standards evolve. Please consult a professional for specific advice.
